FOMC Minutes
A meeting of the Federal Open Market Committee was held in
the offices of the Board of Governors of the Federal Reserve System
in Washing:on, D.C., on Tuesday, November 23, 1965, at 9:30 a.m.
PRESENT:
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Martin, Chairman
Hayes, Vice Chairman
Balderston
Daane
Ellis
Galusha
Maisel
Mitchell
Patterson
Robertson
Scanlon
Shepardson
Messrs. Bopp, Hickman, Clay, and Irons, Alternate
Members of the Federal Open Market Committee
Messrs. Wayne, Shuford, and Swan, Presidents of
the Federal Reserve Banks of Richmond, St.
Louis, and San Francisco, respectively
Mr. Young, Secretary
Mr. Sherman, Assistant Secretary
Mr. Kenyon, Assistant Secretary
Mr. Hackley, General Counsel
Mr. Brill, Economist
Messrs. Baughman, Carvy, Holland, Koch, and
Willis, Associate Economists
Mr. Holmes, Manager, System Open Market Account
to the Board of Governors
Mr. Solomon, Adviser [sic]
Mr. Molony, Assistant to the Board of Governors
Mr. Cardon, Legislative Counsel, Board of
Governors
Mr. Partee, Associate Director, Division of
Research and Statistics, Board of Governors
Messrs. Garfield and Williams, Advisers, Division
of Research and Statistics, Board of Governors
Mr. Hersey, Adviser[sic],
Division of International
Finance, Board of Governors
Mr. Axilrod, Associate Adviser, Division of
Research and Statistics, Board of Governors
Miss Eaton, General Assistant, Office of the
Secretary, Board of Governors
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Messrs. Eastburn, Mann, Parthemos, Brandt,
Jones, Tow, Green, and Craven, Vice
Presidents of the Federal Reserve Banks
of Philadelphia, Cleveland, Richmond,
Atlanta, St. Lou.s, Kansas City, Dallas,
and San Francisco, respectively
Mr. MacLaury, Assistant Vice President, Federal
Reserve Bank of New York
Mr. Geng, Manager, Securities Department,
Federal Reserve Bank of New York
Mr. Kareken, Consultant, Federal Reserve Bank
of Minneapolis
Upon motion duly made and seconded, and
by unanimous vote, the minutes of the meetings
of the Federal Open Market Committee held on
November 2 and 4, 1965, were approved.
Before this meeting there had been distributed to the members
of the Committee a report from the Special Manager of the System
Open Market Account on foreign exchange market conditions and on
Open Market Account and Treasury operations in foreign currencies for
the period November 2 through November 17,
report for November 18 through 22, 1955.
1965, and a supplemental
Copies of these reports
have been placed in the files of the Committee.
In comments supplementing the written reports, Mr. MacLaury
said the Treasury was still debating whether to show a $50 million
decline in the gold stock this week.
The best indications at the
moment were that in the absence of any renewed selling by the Russians
during the next few weeks there would have to be a total reduction
in the stock before the end of the year of perhaps $100 million.
question was simply one of timing.
The
In the London gold market there
11/23/65
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had been no unusual developments during the recent period; the price
had remained in roughly a 3 cent range from $35.10-13, and the gold
pool was on balance unchanged from :he beginning of the month.
The exchange markets had likewise been generally quiet, except
for som
fluctuations in the Canadian dollar.
Sterling was at about
the same levels spot and forward as at the beginning of the month.
There was some pressure on sterling at the time of the Rhodesian
declaration of a state of emergency on November 5, but as it turned
out the limited selling associated with that political development
only served to reestablish the rate at more easily defensible levels.
Despite the quiet appearance of the pound market, the Bank of
England had continued to make good progress in improving its exchange
position this month; it had probably taken in close to $400 million
from the market since November 1.
A sizable part of that would be
used to pay off maturing forwards, but a portion would also be used
for repayment of short-term debts.
It was expected that the $125
million swap drawing scheduled to mature on Friday, November 26, would
be paid off at that time, thus reducing outstanding British drawings
to $475 million and at the same time reestablishing their first-line
credit facility in case it should be needed at some point in the
future.
Mr. MacLaury noted that the Canadian dollar was quoted above
$0.93 during the early part of the month but dropped rather sharply
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when the market learned on November 9 that the U.S. and Canadian
Governments had agreed to cooperate in seeking postponement until
1966 of delivery on a number of Canadian bond issues scheduled for
the U.S. market during the remaining weeks of the year.
The reaction,
though fairly sharp, was short-lived, and the Canadian authorities
had to provide only modest support before the rate turned around
again, helped by bidding for U.S. funds by Canadian finance companies.
Though the discount on the forward Canadian dollar was substantial
(3/4 per cent), it still left an incentive of between a quarter and
a half per cent on a comparison of finance paper rates in the two
markets.
Trading in continental currencies had been quite well balanced
during the month, with only minor fluctuations in rates.
The System
Account had been able to make further progress in paying down the
drawing under the swap arrangement with the Swiss National Bank; only
$14 million equivalent remained outstanding and it was hoped to have
that completely liquidated before the usual year-end repatriation of
funds by Swiss banks began to put pressures on the National Bank's
holdings.
The only other change in the System's position under the
swap arrangements during the period was the drawing of the remaining
$10 million equivalent of Belgian francs under the standby portion
of the facility with the National Bank of Belgium to absorb dollars
taken in by that Bank.
11/23/65
Thereupon, upon motion duly made
and seconded, and by unanimous vote,
the System open market transactions in
foreign currencies during the period
November 2 through 22, 1965, were
approved, ratified, and confirmed.
Mr. MacLaury then presented several recommendations.
He noted
that two swap facilities were scheduled to mature during December:
the $100 million equivalent arrangement with the Netherlands Bank,
with a term of 3 months, would mature December 15; and the $100 million
arrangement with the National Bank of Belgium, with a term of 12
months, would mature December 22.
He recommended renewal of both
of those arrangements.
Renewal of the two swap arrangements
was approved.
The $50 million equivalent fully dr.wn portion of the Belgian
National Bank arrangement was also scheduled to mature December 22,
Mr. MacLaury said, and he recommended its renewal for another 6 months.
The System's balances under this fully drawn portion were unutilized
and thus available in case of need.
The recommended renewal was noted
without objection.
Mr. MacLaury then referred to a memorandum on System participa
tion in forward lira operations, distributed to the Committee under
date of November 18, 1965, in which Mr. Coombs, Special Manager of
the System Open Market Account, recommended that the Federal Reserve
participate with the Treasury in taking over from the Italian Exchange
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11/23/65
Office forward lira commitments and suggested certain implementing
changes in the Guidelines for System Foreign Currency Operations and
the continuing authority directive for such operations.
(A copy
of the memorandum has been placed in the files of the Committee.)
Mr. MacLaury said Governor Carli of the Bank of Italy had
requested that the U.S. authorities assume additional commitments in
the amount of $500 million equivalent.
As the Committee knew, the
Treasury now had outstanding $1 billion equivalent of such commit
ments.
The recommendation of Mr. Coombs for System participation
in the operation was not prompted by an unwillingness on the part
of the Treasury to extend its commitments further--clearly, if there
had been any question on the part of the Treasury as to the usefulness
of the operation, it would never have allowed its participation to
reach present levels.
Rather, it was felt that the Federal Reserve
should itself be associated directly with the Italian authorities
in their efforts to minimize the potentially disruptive effects of
their large surplus on international financial markets and the U.S.
gold stock.
There was no need to dwell on the consequences for the
U.S. and the rest of the world if Italy had followed the example of
France during the past year.
Instead, the Bank of Italy had consistently
taken the initiative in seeking ways to strengthen the international
financial system without undercutting the position of the dollar;
insulating the system from the shocks of the sharp Italian payments
11/23/65
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swings had been an important contribution in
that direction.
Indeed,
had the Italian authorities not channeled such a sizable volume of
funds into the Euro-dollar market this past year, it seemed quite
likely that the resulting strains would have required Federal Reserve
intervention on a far larger scale than in fact was necessary.
It
seemed far preferable, therefore, that the Federal Reserve encourage
the type of constructive policies being pursued by the Bank of Italy
by associating itself with them rather than, in effect, find itself
forced into salvage operations by the absence of such policies.
As for the System's exposure to risk in taking on forward
lira commitments,
Mr.
Coombs'
memorandum had pointed out that the
terms of the arrangement precluded any losses resulting from a
revaluation of the lira,
existing margins,
from exchange rate fluctuations within the
or from failure to delived on the part of an
Italian commercial bank.
Indeed, except in the case of a devaluation
of the dollar vis-a-vis the lira, the U.S. would never have to acquire
lire to pay off maturing contracts since it was agreed that the con
tracts would be taken over again by the Italian authorities at the
time of their final liquidation by the Italian commercial banks.
Mr. MacLaury emphasized that the Committee, if it approved
the recommendation that the System take on forward lira contracts
in conjunction with the Treasury, would not be venturing into new
11/23/65
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areas or departing from previous policies.
Except for the lesser risks
involved, the Italian forward operation was not different in nature
from other operations previously undertaken by the Federal Reserve.
Only a minor change would be required in the Guidelines for System
Foreign Currency Operations to authorize forward exchange trans
actions that would indirectly (i.e., by backing up the Bank of Italy)
as well as directly supplement market supplies of forward cover to
encourage retention or accumulation of dollar holdings by private
foreign holders.
There followed a discussion in which Mr, MacLaury responded
to several questions bearing generally on how the proposed System
operation would work in terms of the various parties involved,
including the Federal Reserve, the Italian Exchange Office, and the
Italian commercial banks.
In the course of his explanation,
Mr, MacLaury brought out that the System would in effect be providing
a guarantee tc the Exchange Office against devaluaton of the dollar.
This was the type of guarantee the System give when it drew under swap
arrangements; it was not a gold guarantee.
Mr. Scanlon asked whether the forward contracts would be for
3 months or more, and Mr. MacLaury replied that they would be for a
period of not more than 3 months.
Mr. Scanlon then asked whether it
could not be anticipated that they would have to be rolled over, to
which Mr. MacLaury replied that they probably would be rolled over
11/23/65
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until there was some change in the Italian payments picture.
Mr. Scanlon commented that he agreed completely that the Italians
should be enccuraged to continue to do what they had been doing.
But he questioned whether the proposed operation did not amount to
getting into the longer-run area, and if so whether this would not
require a broader amendment than had been suggested in the Guidelines
for Foreign Currency Operations.
Mr. Daane remarked that much would depend on the Italian
payments position, which could shift very rapidly, as it had in the
past.
Meantime, it quite clearly served the U.S. interest to give the
Italian commercial banks an incentive to hold dollars and avoid a drain
on gold, part..cularly when there was no risk involved.
While this
was an operation that could not be pinpointed from a time standpoint,
he did not think one could say it was definitely an operation of
long duration, assuming the Italians continued their efforts to move
back to payments equilibrium,
Mr. Scanlon reiterated that he was not in disagreement with
the proposal.
He was merely raising the question whether the Guide
lines did not require some broader revision than proposed.
Mr. Maisel said it appeared to him that a major change in the
whole concept of System foreign currency operations was involved,
which change the Committee was being asked to approve on an ad hoc
basis.
If there was no great urgency, he felt that the proposition
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11/23/65
should be turned back to the staff for re-examination in the light
of the overall question.
It seemed to him the Committee should not
change its policies by acting on propositions that were brought
before it one at a time on short notice.
Mr. Daane said the type of operation currently being proposed
would represent no departure from precedent from the Treasury stand
point, for the Treasury had initiated such operations in 1962.
Nor
did he believe that it would represent in principle any shift in policy
from the Committee's standpoint.
The principle seemed to him clear.
It amounted to protecting the U.S. gold stock and assisting a country
that had been trying to be helpful to the U.S.
It was his under
standing that the Italian authorities had come to the U.S. authorities
with a request, and he felt that action should not be deferred.
Mr. Mitchell asked whether, if the proposal was considered
basically desirable, the Committee should not get down to the issues.
He understood that the System would not be giving a guarantee
different from what it had previously given in connection with swap
operations.
It would not be giving a gold guarantee, only a guarantee
in terms of the lira.
If so, the remaining question related to the
duration of the operation.
Mr. Scanlon might have a point in saying
that there should be some broader modification of the Guidelines to
accommodate an operation of this kind.
Under the swaps, drawings were
generally limited to 3 months, with at most 3 extensions if necessary.
11/23/65
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Mr. MacLaury commented that although one could not foresee
exactly how long this kind of operation might be required, there was
no reason to believe that the Treasury would be unwilling to take
another look if the Committee felt at some future date that the
operation was running on too long for a System operation.
Mr. Hickman suggested that at the end of a year the Treasury
might be asked to take over, and Mr. Daane
said he felt sure that if
at some point the Committee decided it was in the interest of the
System to get out, the Treasury would be willing to provide a
takeout, particularly since there was no rik involved.
Mr. MacLaury observed that the Treasury had provided a
takeout on a small number of occasions when the Committee felt that
swap drawings had run on longer than desirable.
Mr. Shepardson asked whether the System operation would be
in addition to what the Treasury was doing, and Mr. MacLaury replied
in the affirmative.
The Treasury now had taken over $1 billion
equivalent of forward lira commitments.
If the System took on the
proposed $500 million, the total taken over by the Treasury and the
System would be $1.5 billion.
Mr. Shepardson then asked whether, at
the end of a year, if the Committee decided it wanted to get out the
Treasury would take over the $500 million, and Mr. MacLaury said he
felt sure it would.
He reiterated that Mr. Coombs' recommendation
that the System become involved was not based on any reluctance on
the part of the Treasury to extend its commitments further.
11/23/65
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Mr. Shepardson then said that although he was not objecting
to the proposed procedure, it was not entirely clear to him why, if
the Treasury had been doing this and would have no objection to
increasing its commitments, the System should step in.
Mr. Hayes commented that the Committee had tried to move in
parallel with the Treasury on most foreign currency operations,
except where they were clearly long-term operations at the outset.
As to the current proposal, there was no way of knowing at the outset
how long an operation would be involved.
However, judging from past
experience the Italian balance of payments tended to involve
swings
of major propostions within fairly short periods, so there was a
good chance of the proposed operation being a short-term self
liquidating proposition.
Starting with that as a possibility, it
made a lot of sense for the System to participate in partnership with
the Treasury.
It would fit in with the kind of operation the System
had been conducting by means of the swap arrangements.
The System
would retain the opportunity to go to the Treasury and ask it to
take over if the operation became a drag on the System, just as that
privilege had been retained right along in connection with trans
actions under the swap arrangements.
Mr. Daane noted that the operation clearly had the aspects
of a central bank cooperative venture.
From the Italian standpoint,
it would enable the Bank of Italy to avoid getting into an
embarrassing position by having too high a dollar ratio in its reserve
11/23/65
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position.
The operation was a central bank-to-central bank gesture
and thus was quite clearly within the purview of the System.
Mr. Mitchell remarked that it was essentially a substitute
for a swap--and in his opinion a much more desirable relationship.
It was one that not too many other foreign countries presumably
would go along with.
But he felt the Guidelines probably should
contain some recognition of the potential duration and some kind of
limitation.
He suggested 9 months or a year as a time limit.
Mr. Shepardson pointed out that the Committee had fixed a limit
of a year on swap drawings remaining outstanding.
Chairman Martin remarked that he saw no objection to so
changing the Guidelines.
He did not think it essential, however,
because this was an experimental operation.
Mr. Mitchell inquired whether, if the Committee approved
Mr. Coombs' proposal, this would make it possible to enter into
similar undertakings with countries other than Italy, or with the
Italians again, and Mr. Young pointed out that the recommended
change in the continuing authority directive was directed solely
to the lira arrangement.
Mr. MacLaury commented that the proposed
minor change in the Guidelines did not prejudge in any way whether
the Committee would wish to conduct this kind of operation again
with the Italians, or any other country.
As Mr. Young had indicated,
the recommended change in the continuing authority directive was
11/23/65
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stated entirely in terms of the lira, but that directive could,
of course, be revised at a later time if the Committee so desired.
Mr. Mitchell repeated that he thought this method of
operation was preferable to the swap arrangement, and that it
should he encouraged if any other country was willing to go along.
Mr. MacLaury said he would be reluctant to agree that it
was a preferable method of operation.
It was a viable alternative
in this particular instance, but the System had used a number of
operating techniques, all of which were potentially valuable, and
any one of which might have special advantages in a particular
situation.
Mr. Hayes commented that if there was another case where it
appeared desirable that a transaction similar to the Italian operation
be entered into, that would have to be brought before the Committee,
and Mr. Maisel said this was precisely the point about which he was
concerned.
It seemed to him that the Committee's policies should be
thought out logically in advance.
He was not going to dissent from
the current proposal, especially in light of the reported pressure
of time.
But he considered it important that the Committee get
some staff views on where it was going in the longer run in foreign
currency operations, and on the relationships between various types
of operations, so it would not be called upon to react to one
proposal after another on an ad hoc basis,
Adding one authority
after another was a poor way of doing business.
11/23/65
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Chairran Martin then suggested approving the current
proposition and asking the staff to give the Committee a memorandum
on the broader subject, and there appeared to be general agreement
with this suggestion.
Mr. Hayes commented, however, that he did not think the
Committee had been acting on an ad hoc basis to the degree Mr. Maisel's
remarks suggested, following which Mr. Ellis. commented that he
thought it would be appropriate to distingu:sh between what the
New York Bank was directed to do and what it was authorized to do.
The language of the continuing authority directive said the Bank was
both authorized and directed to do various things.
In the present
case, in the absence of legal considerations with which he was not
familiar, he thought all that was really needed was to authorize the
Bank to operate in the manner proposed.
Mr. Young brought out that the language proposed for the lira
arrangement would be consistent with that found in other paragraphs
of the continuing authority directive.
However, the point raised by
Mr. Ellis could be reviewed by the Committee's Counsel before the
continuing authority directive came up for reaffirmation by the
Committee next March.
Mr. Daane then suggested that, in view of the questions raised
by Mr. Maisel and Mr. Ellis, the staff take a complete look before
the March meeting at the Guidelines and authorities covering System
foreign currency operations.
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11/23/65
Chairman Martin proposed proceeding on that basis, and no
objection was heard.
Thereupon, upon motion duly made and
seconded, and by unanimous vote, paragraph
2 of section 4 of the Guidelines for System
Foreign Currency Operations was amended to
read as follows, effective immediately:
When it is deemed appropriate to supplement existing
market supplies of forward cover, directly or indirectly,
as a means of encouraging the retention or accumulation of
dollar holdings by private foreign holders.
Upon motion duly made and seconded, and
by unanimous vote, the following paragraph
was added to the continuing authority directive
for foreign currency operations:
The Federal Reserve Bank of New York is also authorized
and directed to assume commitments for forward sales of
lire up to $500 million equivalent as a means of facilitating
the retention of dollar holdings by private foreign holders.
Before this meeting there had been distributed to the members
of the Committee a report from the Manager of the System Open Market
Account coverirg open market operations in US. Government securities
and bankers' acceptances for the period November 2 through 17, 1965,
and a supplemental report for November 18 through 22, 1965.
Copies
of both reports have been placed in the files of the Committee.
In supplementation of the written reports, Mr. Holmes commented
as follows:
The past three weeks have been interesting ones for
those of us on the Trading Desk. As you will recall we
started out the period after the last Committee meeting
with a fairly poor reception of the Treasury's November
refunding operation, with even keel considerations well
11/23/65
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to the fore. Before that statement week was over we ran
into the power blackout, which also blacked out any real
knowledge as to where the New York money market banks
stood with respect to their reserve positions or where
the System stood with respect to nationwide reserve
availability. Following the blackout--but with no causal
connection--we had some recovery in the Government bond
market and, for the first time since I became Manager of
the System Open Market Account, a statement week--the
week ending November 17--in which we conducted no operations
in Government securities.
The reserve statistics have of course swung rather
widely as a result of the November 9 power blackout in the
northeast. Despite a swing from free reserves of about
$100 million in the week ending November 10 to net borrowed
reserves of about $200 million in the week ending November 17,
the money market has been more consistently firm than one
might have expected. Federal funds traded predominantly
at 4-1/8 per cent on every day except one, when a 3-1/2 per
cent effective rate prevailed. As the written reports
explain mo:e fully, the disruption in bank operations caused
by the blackout made the free reserve figure a meaningless
one. By the same token, the large reserves carried over into
the November 17 week by the New York City banks were absorbed
by the fall in over-all reserve availability and a buildup
in excess reserves at country banks. The chief visible
result of the gyrations in reserve statistics was the re
covery in average member bank borrowings from the Reserve
Banks from $334 million in the first full statement week of
the period to a more normal $489 million in the second.
Over the period Treasury bill rates have edged a bit
higher, but it is well to remember that the market has taken
on $6.5 billion tax bills in the past two months. The
market has functioned smoothly and dealers have had sufficient
confidence in the viability of existing rate levels--and in
System needs to supply reserves over the next few weeks--to
build up substantially their portfolios of Treasury bills,
including bills put out on repurchase agreements maturing
over the December dividend and tax dates. The Treasury's
auction of $2.5 billion June tax anticipation bills last
Tuesday proceeded uneventfully, and the sale of the bills
by the banks that bought them through the tax and loan
accounts to the dealers has been progressing without diffi
culty. In yesterday's auction a good interest was evident
with the 3- and 6-month bills going at about 4.10 and 4.25
11/23/65
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per cent, respectively. Early bidding ideas for today's
auction of one-year bills are in a range of 4.25 - 4.27
per cent.
Prices of Treasury notes and bonds declined to the
lowest levels of the year in the early part of the recent
period as a result of the rapid buildup of the calendar
of new corporate offerings and the lukewarm reception given
the Treasury's November refinancing. The initial market
reaction to the results of the refunding was moderated by
purchases of the new 4-1/4 per cent ncte for Treasury
accounts. The new issue itself held up well thereafter,
and System purchases of the when-issued securitiesdiscussed at the special November 4 telephone meeting of
the Committee--were not required. Subsequently, a better
atmosphere developed as the large volume of new corporate
issues attracted a generally more favorable response, and
at somewat lower rates, than had earlier been expected.
Some market participants were also impressed by the
Administration's success in rolling back the aluminum
price, and the implications of this for monetary policy.
Many market observers continue to expect, however, that
yields are likely to work higher over the months ahead.
Although the tone in the corporate market improved, yields
on municipal bonds rose irregulacly throughout the interval.
While dealers in the bond markets have been encouraged to
some degree by the recent performance, the markets still
remain susceptible to sudden changes in sentiment in
response to changing conditions.
Perhaps a word is in order about the special pressures
that typically focus on the banks and the money market
over the coming mid-December period. Bankers, Government
securities dealers, and other participants in the short
term market are of course well aware of these special
pressures, although they realize that the degree of pressure
can vary considerably from year to year. Given the greatly
enhanced importance of certificates of deposit, a great
deal of actention is being focused on the problems that the
commercial banks face over the forthcoming period of tax
and dividend payments and simultaneous peak credit demands.
New York banks are now generally offering rates of 4-1/2
per cent for 3-month CD maturities, and banks generally appear
to be stepping up their efforts to place unsecured promissory
notes at rates that are above the Regulation Q ceilings
for certificates of deposit.
11/23/65
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Despite tensions and uncertainties, particularly with
regard to the ability of the banks to compete for funds,
the market appears to be generally confident that
December--barring any sudden upsurge in credit demandswill not bring undue stresses and strains. Reliance is
being placed in part on a high level of cash flow of the
automobile companies, and in part on expectations of an
absence of any sharp change in capital market conditions.
But the market is mainly relying on the Federal Reservethrough open market operations--to make at least the
customary provisions for the special demands of the period
of peak pressure just ahead.
As Ear as the Treasury financing schedule is concerned,
the November refunding can now be considered to be pretty
much out of the way. Payment for the second instalment of
June tax anticipation bills is due on Wednesday, and as
noted earlier there have been no problems thus far in the
distribution of these bills. The Treasury will have to be
back in the market again in January, with the likelihood
that a cash financing covering at least part of January
needs will be announced before the end of this year.
Mr. Hickman referred to Mr. Holmes' comment that the November
Treasury refunding could now be considered pretty much out of the way.
Yet payment was not due until tomorrow on the tax anticipation bills,
and presumably the distribution of the bills would go on for a week or
more.
Mr. Holmes replied that many banks had sold the bills on a
when-issued basis.
completed.
Thus, a good part of the distribution had been
There appeared to be no great pressure for distribution of
the remaining bills.
Asked about dealer positions, Mr. Holmes said they had been
built up quite substantially in the belief that the Federal Reserve
would be in the market to buy at least $1 billion of securities in
order to accommodate seasonal reserve needs.
11/23/65
-20Thereupon, upon motion duly made
and seconded, and by unanimous vote, the
open market transactions in Government
securities and bankers' acceptances during
the period November 2 through 22, 1965,
were approved, ratified, and confirmed.
The staff economic and financial report today was in the form
of a visual-auditory presentation. (Copies of the charts have been
placed in the files of the Committee.)
The introductory portion of the review, presented by Mr. Koch,
was as follows:
Progress this year has brought us much closer to
achieving out national economic goals. Unemployment has
declined, while production, personal incomes, and consump
tion have advanced. The economy, stimulated in part by
increased military activity, is operating closer to full
potential now than at any other time in nearly a decade.
Fortunately, price increases thus far have continued to be
selective, and no pervasive upward pressures on prices
or costs have developed. Internationally, our payments
balance, though far from satisfactory, has taken a turn
for the better, as the voluntary foreign credit restraint
program has proved effective.
Appropriate policy decisions in an environment like
this are especially difficult to make. It might not take
much of a move toward ease or restraint of either monetary
or fiscal policy to tip the scale towar. inflation on the
one hand or recession on the other.
Our analysis this morning deals with some of the major
issues and problems of economic policy associated with
increased use of resources, both nonfinancial and financial.
It is selective, counting on the green book 1/ for a more
detailed and comprehensive coverage of most recent developments.
1/ A document entitled Current Economic and Financial Conditions
prepared by the staff and distributed under date of November 17,
1965; a supplement was distributed under date of November 19. Copies
have been placed in the files of the Committee.
11/23/65
-21Mr. Hersey then presented the following discussion of
international developments:
Last February, the President announced a program to
"achieve a substantial reduction in our international
deficit during 1965, and secure still further improvement
in 1966."
The 1965 part of this objective is being ful
filled. The deficit on the "liquidity" basis will probably
be about $1-1/2 billion, compared with more than $2-1/2
billion in almost every one of the previous 7 years. The
deficit on the new "official settlements" basis will
probably be only about $1/2 billion, compared with $1-1/4
billion last year and substantially more in earlier years.
The 1965 deficit would have been even smaller had the U.K.
Treasury not converted about $1/2 billion of its security
portfolio into assets we count as liquid.
This year's improvement has occurred despite a
decline in the current account surplus. It has resulted
from a very sharp reduction in the net outflow of U.S.
private capital, from $6-1/2 billion, the average for the
two halves of 1964, to an annual rate of about $3-1/2
billion in the first half of this year, and also in the
third quarter. Now, what is the prospect for capital
outflows in 1966?
This year, a sharp cut in bank credit outflow has
been achieved under the voluntary restraint program,
reinforced by the interest equalization tax and also by
stronger domestic credit demands and more moderate demands
from some foreign borrowers. With the restraint program
continuing in 1966, outflows of bank credit (that is,
loans and acceptance credits) may be held near this year's
reduced average--about $150 million per quarter. The
substantial reflow of U.S.-owned liquid funds (including
banks' liquid claims as well as those of corporations)
during the first half of 1965 was a once-for-all phenomenon,
and the expected diminution of reflow, already apparent in
the third quarter, will represent a sizable element of
worsening between 1965 and 1966.
Direct investment outflow expanded very sharply late in
1964 and early this year. It has since diminished, but the
year's total will be very large. The voluntary program is
being strengthened to hold down such outflows in 1966; but
there seems little prospect of a reduction sufficient to
offset fully the expected shrinkage in reflows of liquid
funds. Finally, outflows into foreign securities seem
11/23/65
-22-
likely to remain of moderate size, with the bulk continuing
to go to Canada. Canadian issues have been exempted from
the interest equalization tax on the understanding that they
would not increase Canadian reserves.
In fact, Canadian reserves have risen considerably
since that understanding was reached in 1963, and have
continued to rise this year, partly owing to large wheat
sales to Russia. As a result, U.S. and Canadian authorities
have taken action to obtain deferment of further new
Canadian security issues in this country until next year.
Changes in credit conditions this year may have begun
to reduce incentives to U.S. capital outflow. Credit has
tightened somewhat here, and has eased in Japan, Italy,
France, and Belgium. But credit demands from Canada and
the less developed countries remain strong. The United
Kingdom may continue to attract flows from other countries
as confidence in sterling recovers further. Interest rates
are very high in Germany, and once they stop rising, the
prospect of capital gains on German bonds may become
attractive.
Thus, balance of payments improvement in 1966 is
probably not to be expected from a further net reduction in
total outflows of U.S. capital, even with some strengthening
of voluntary restraints. It must come mainly from renewed
expansion of the current account surplus, with possible
assistance from cessation of British sales of U.S. securities
This year the current account surplus diminished to a
$6 billion rate in the first half, but picked up in the
third quacter to nearly the $7-1/2 billion level first
attained Last year.
A sharp rise in U.S. merchandise imports contributed
deterioration during the first half
to the current acccount[sic]
of 1965. Now, as steel imports subside, total imports may
settle back within their past range in relation to GNP.
But the general tendency in recent years has been for imports
to rise at least as rapidly as GNP.
Exports dropped sharply during the first quarter because
of U.S. port strikes, and the shortfall was not made up in
the second quarter, partly because of slackening demand in
Japan, in some European countries, and in some less developed
countries. In the third quarter, exports rose encouragingly,
to a level 7 per cent higher than a year earlier. But with
imports up 12 per cent over the year, the trade surplus was
not yet back to the 1964 highs.
11/23/65
-23-
One fundamental change in underlying trends has made
achievement of a rising U.S. trade surplus more difficult.
In the past two years, economic expansion has become more
rapid in the United States than in Europe, where labor force
growth has been very small. European import demands have
risen faster than output, but have been weakened, until
lately, by recession in Italy and slower growth in France.
Renewed expansion is now under way in those two countries.
However, their rising import demand may be offset by some
easing of demand in Britain.
On balance, the trade surplus next year may be near
the third-quarter level. This would mean a gain for 1966
over 1965. On other types of current transactions, little
net change is anticipated. The gradual reduction of net
military expenditures has now ended, and is beginning to
be reversed. But further growth of net investment income
is likely as a result of continued additions to U.S. direct
investments abroad. Thus, it appears that the current
account surplus will increase in 1966.
Accordingly, there should be some further improvement
in the over-all payments position, if outflows of U.S.
capital are held down by the voluntary programs and if U.K.
Treasury sales of securities end.
But beyond 1966, it will become increasingly difficult
to limit capital outflows by voluntary programs. Since
the objective in any case should be to permit greater
freedom, continued improvement in the current account will
be needed. In this connection it remains of crucial im
portance to avoid inflationary developments in the U.S.
economy, so as to take full advantage of price increases
still occurring in most industrial countries abroad
despite their anti-inflationary programs.
Mr. Garfield commented as follows on domestic business
developments:
With a further substantial rise in GNP in the current
quarter, the total increase from the fourth quarter of 1964
to the fourth quarter this year will be about $48 billion.
This is considerably larger than the rise over the previous
four quarters, but after allowance for last year's auto
strikes this year's increase in GNP is similar to last
year's. So also is the increase in consumer expenditures.
Increases in business fixed investment and in State and local
government outlays also are similar, and residential construc
tion has shown little change for more than 2 years.
11/23/65
-24-
Inventory accumulation--although large for 1965 as a
whole--in the current quarter is down appreciably from the
fourth quarter of 1964 because of the shift to liquidation
of steel stocks. Federal spending is up substantially
from a year ago, mainly as a result of intensified operations
in Vietnam.
Continued expansion in business fixed investment and
the upturn in Federal outlays have played major roles in
maintaining the rate of increase in total output and thus
in raising rates of resource utilization. That these
categories of spending will continue to expand well into
next year has become increasingly evident, and present
uncertainties focus on the likely degree of expansion in
relation to growth in available resources.
Turning first to the Government's role, the impact of
Federal activities in 1965 is not adequately described by
the increase in spending for goods and services. Receipts
rose sharply in the first half; the resulting shift to
surplus in the national income budget and the growing
full employment surplus once again provoked discussion
In the second
of tax reduction to deal with "fiscal drag."
half, the cut in excise taxes, increasing expenditures for
Vietnam, Government pay increases, and retroactive advances
in social security benefits comb:ned to throw the budget
back into deficit.
Looking ahead, military spending and social security
payments are expected to rise further in the first half of
1966, and additional excise tax cuts take effect. However,
increased social security and other tax receipts will more
than compensate, and the actual deficit will be reduced.
Clearer assessment of the impact of likely Federal
operations must await the January budget announcement,
which may have immediate effects on expectations and
business decisions. But judgments about the impact of the
budget must also depend in part on the strength of private
demands.
Business plans to add to plant and equipment remain
strong. Although outlays for 1965 as a whole are up 13
per cent from last year and almost 40 per cent from three
years ago, the McGraw-Hill survey shows a further rise of
8 per cent for next year. Spending might rise even more;
in the past two years realized gains were 8 to 10
percentage points greater than anticipated by the autumn
surveys.
11/23/65
-25Business fixed investment, as shown in the GNP accounts,
has been rising at an annual rate of 10 per cent. Over
the past year, resources have been available to permit this
increase and also the expansion it contributed to in other
types of spending without a general rise in prices.
The share of fixed investment in GNP increased some
what. further, almost to the 1956 proportion. Given the large
expansion already achieved, the question arises whether
investment plans for next year are solidly based on supporting
faccors. First of all, would continued increases in output
at recent rates maintain capacity utilization at recent
advanced levels?
Measures of change in capacity are available only for
manufacturing, which accounts for a third of GNP and a half
of plant and equipment outlays. The McGraw-Hill survey of
last spring showed an increase in manufacturing capacity for
this year of 6 per cent--a historically high figure but no
higher than the rate at which manufacturing output has been
increasing since early 1963. Next year's capacity increase,
resulting partly from outlays already made, is likely to be
greater--oerhaps 6-1/2 or 7 per cent. This would not be
appreciably in excess of the 6 per cent rate of expansion
in output since 1963; but any important slowing of the
expansion in output could provoke downward revision of
plans for further increasing capacity. Outlays for
replacement and modernization, which still account for more
than half of the total, are also subject to change with
changes in expectations.
If producers do fulfill their plans for increasing
plant and equipment outlays, can the machinery industries
cope with the resulting demands? Recently shipments of
machinery have continued to trail new orders although
reported operating rates in the machinery industries are
not yet up to 90 per cent.
Capacity in the machinery industries reportedly has
increased 5 or 6 per cent this year compared with only
3 per cent in 1964, and sharply rising investment expendi
tures by these industries suggest that expansion of their
capacity is accelerating further. If so, it appears that
new orders can rise almost as fast as they have been rising
without unduly increasing backlogs. Appreciable upward re
vision in spending plans, however, would be likely to widen
the gap between new orders and shipments, and would foster
a climate in which upward pressures on prices and costs
tend to mount.
11/23/65
-26-
Although rates of resource utilization have
increasec further this year, business decisions are being
made against a background of selective rather than widespread
upward pressures on prices. The wholesale index has tended
to level off following its increase in the first half of the
year. The rapidity of that increase reflected mainly a
rise in foodstuffs, as livestock prices increased sharply
in response to curtailment in production, but the industrial
index was also rising. In the 9 months from September 1964
to June 1965, industrial prices rose at an annual rate of
2 per cent; since June the rise has slowed to a 1 per cent
rate.
The selective nature of the rise is illustrated by the
dispersion of changes among 70 groups of industrial commodi
ties. A large proportion of commodity groups were practically
unchangec--32 per cent in the period from September 1964 to
June 1965, and 46 per cent in the period from June to
October. In both periods the proportion of groups increasing
exceeded the proportion decreasing--by about three to one;
but most changes were small.
Nonferrous metals account for much of the rise of 1.7
per cent in the industrial group since September 1964.
Releases from the stockpile will help to meet increased
military requirements for copper and aluminum. The copper
situation threatens to become worse, w.th new strikes in
Chile and uncertainty about supplies from Zambia and Katanga.
The recovery in prices of petroleum products also made a
large contribution to raising the industrial index.
Most other major materials have shown little if any
increase. Textile prices and mill margins are inflated in
that fiber prices have declined while product prices have
not. Among paper products and chemicals, increases have
been scattered. Of 105 industria' chemicals, only 22 have
increased from a year ago while 8 have declined and 75 have
not changed; the average is up 1 per cent.
Steel products have increased little since 1963, the
nonmetallic minerals group has been stable, and lumber and
plywood have been dominated by seasonal and other short-run
influences.
Altogether, increases in prices of industrial materials
have been large in only a few cases, and while wage rates
have continued to rise, increases in unit labor costs have
been neither widespread nor large. Prices of finished in
dustrial products have not been subjected to pervasive upward
pressures of costs, and the rise in the over-all industrial
price index has been moderate.
-27-
11/23/65
Continuation of this relatively favorable price
cost performance may prove possible, provided business
investmen: and Government outlays do not rise
considerably faster than indicated by current plans.
Projected increases for these and other outlays, given
continued growth in industrial capacity and the labor
force, would not appreciably change rates of resource
utilization.
Mr. Partee presented the following comments on financial
developments:
Financial markets, more than markets for goods and
services, have shown evidence of strains on available
resources this year. Bank liquidity has been reduced
further, and interest rates have risen significantly.
An attempt to identify the sources of ncreased financial
market tensions--in particular, to differentiate basic
forces of demand and supply from the effects of changing
market expectations--should help to provide perspective
on the probable course of financial developments in the
weeks and months ahead. We turn first to a review of
credit demands.
Funds were raised by private domestic nonfinancial
borrowers--individuals, businesses, and State and local
governments--at an annual rate near $65 billion in each
Though declining
of the first three quarters of 1965.
slightly in the third quarter, private borrowing has
Increased private
remained larger this year than last.
spending has been primarily responsible, but the ratio
of private credit expansion to spending also has risen.
Federal borrowing, seasonally adjusted, declined
in the second quarter--and also in the third, when the
Treasury ran down its cash balance. Foreign borrowing
also fell below the first quarter high, as the voluntary
credit restraint program curbed bank lending abroad.
As a result, total credit flows fell to a seasonally
But this was, in
adjusted low in the third quarter.
large part, a consequence of Treasury debt operations
that are now crowding a large volume of cash financing
into the final three months.
On the demand side of credit markets, pressures on
available funds have come mainly from unusually large
business borrowing, especially from banks. The annual
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11/23/65
growth rate of business loans has remained well above
that of earlier years, though declining from quarter to
quarter.
Further tapering occurred after the steel
settlement, but figures for recent weeks suggest some
resurgence in loan demand.
In contrast with business borrowing from banks,
corporate security issues have risen over the course of
the year, and the calendar for the weeks ahead is heavy.
This reflects primarily the continuing expansion in
plant and equipment spending, but may also be related to
reductions in corporate liquidity. In the fourth quarter
of last year, seasonal increases in corporate liquidity
ratios were smaller than usual, ard reductions so far
this year have been substantially larger than the trend
of the past several years.
Consumer borrowing also has been relatively large
this year. Increases in total consumer credit have been
at annual rates of about $9 billion in each of the past
three quarters, compared with a $7 billion increase in
1964.
Municipal security issues, on the other hand, have
been only moderately larger than in the past two years.
Mortgage debt has continued to expand at about last
year's $26 billion pace.
The unusually rapid growth of business loans at
banks has been broadly distributed by irdustry. The
effects of the steel inventory buildup are clearly
evident in the borrowings of metals and metals-using
firm; at weekly reporting member banks. Borrowings of
public utilities and trade firms also nave been large.
In fact, growth in bank loans to business exceeded
year-earlier figures in all major industrial categories,
reflecting the general strength of busiress investment
as the economy moved toward higher resource utilization.
Growth in business fixed investment and inventory
accumulation since the third quarter of 1964 has been
considerably larger than the expansion in gross retained
earnings, and has been the principal factor increasing
business external financing. Capital spending abroad
also has risen. Additionally, the distribution among
industries of the growth in retained earnings has not
matched that of investment.
Retained earnings in
manufacturing, for example, were up sharply in the first
quarter, but declined in the second quarter and possibly
also in the third. In contrast, manufacturers' outlays
11/23/65
-29-
for fixed investment and inventories have continued to
rise rapidly.
The resulting increase in business credit demands,
which focused heavily on the banking system, encouraged
banks to bid more aggressively for funds, and rates on
CD's and Federal funds continued the rise that had begun
late in 1964. Monetary policy, meanwhile, pursued a
course that required a larger portion of the increase in
half to come through the
bank reserves during the first
discount window. Member bank borrowings rose to a peak
in August: and have declined only slightly since then.
Movements in free reserves have mirrored the pattern in
borrowing this year, since excess reserves have changed
little.
Reduced reserve availability during the second
quarter was accompanied by a moderately slower growth
rate of total bank reserves than had prevailed earlier
Then, in the third quarter, total bank
in the year.
reserves declined--as Treasury deposits fell sharplyand reserve growth did not resume until October.
The third quarter contraction in Treasury deposits
was not fully offset by more rapid growth of private
deposits, so that expansion in total bank deposits
slowed. Growth of the money stock did accelerate in
the third quarter, however, and by the end of October
the annual growth rate for the year to date had risen
Time
to 4.4 per cent, about equal to the 1964 rate.
deposit growth also increased in the third quarter,
partly as the result of the success of banks in
marketing savings certificates and bonds.
The unusual pattern of Treasury financing this year
has made changes in bank credit difficult to interpret.
A measure that circumvents some of the difficulties is
the growth of bank credit exclusive of changes in bank
holdings of Treasury securities and bank loans to
brokers and dealers secured by Governments. This can
be viewed as a measure--though imperfect--of the banking
system's contribution to the financing of private
spending.
Net new funds supplied to private borrowers by
banks declined in the third quarter, and the decline
exceeded that in total private borrowing. Funds
supplied by other savings institutions showed little
increase, as these institutions continued to feel the
pressure of competition for savings flows from
commercial banks. The private nonfinancial sectors,
11/23/65
-30-
as a result, had to supply a larger quantity of funds
directly to the private credit markets in the third
quarter than in other recent years. Higher interest
rates were required to encourage them to enlarge their
purchases.
This increase in funds supplied by individuals and
businesses was accompanied by growing expectations that
private credit demands might rise further, in line with
continued vigorous expansion in economic activity. It
was recognized, also, that the Treasury would soon be
returning to the market in volume. The swing in market
expectations reinforced the more basic forces of demand
and supply, and also exerted upward pressure on interest
rates. The rise in market rates of interest in evidence
prior to midyear in the corporate and municipal bond
markets became more general as rates on Treasury issues
joined in the advance during August. Rate increases
since early summer have been both rapid and substantial;
yields on long-term corporate and Treasury issues are
close to the peaks of early 1960. Rates on municipals
and on Treasury bills also have increased since midyear,
but are still below their earlier peaks.
The concluding part of the staff presentation was given by
Mr. Brill, who reviewed more recent developments in financial markets
and then summarized the analysis and its implications for policy,
as follows:
Interest rate pressures developing during the third
quarter continued in evidence in October and early
November, as market conditions reflected heavy Federal
borrowing and uncertainties about military spending,
the potential strength of private credit demands, and
the course of monetary policy. Most recently, markets
for Treasury securities have quieted somewhat and rates
have shown some signs of leveling. Nonetheless,
conditions in financial markets remain taut and market
sentiment uneasy, with peak seasonal pressures just
ahead.
Are existing financial conditions appropriate, in
the light of developments in the real sectors of the
economy and in the balance of payments? Thus far, price
changes in commodity markets have continued to be
11/23/65
-31-
selective and, for the most part, moderate. Since June,
increases in the industrial average have been smaller
than earlier. The Administration's efforts to contain
wage rate advances in key industries, and to hold the
line on prices of basic industrial materials, have no
doubt contributed to this stability.
But availability of resources to meet expanding
demands has been a more fundamental factor in containing
price pressures. Next year's additions to plant capacity
are likely to be even larger than this year's, and
additions to the labor force are also expected to be
larger. At the same time, resources of efficient plants
and trained workers are not unlimited, and new price
pressures could develop if military activities increase
substantially or investment spending rises much faster
than is now indicated.
In our international payments accounts next year,
moderate further improvement seems likely, in view of
the probable increase in the current account surplus
and the additional measures planned by the Department
of Commerce to hold down direct investments abroad.
Such progress will depend importantly on maintenance of
our favorable cost/price record, as well as the continued
cooperation of the financial community and increased
cooperation of nonfinancial corporations in restraining
capital flows.
If an assessment of economic pressures and of other
Government policies should lead to the conclusion that
the present stance of monetary policy is appropriate,
what would this mean operationally, in terms of reserve
targets and money market relationships?
Any answer must
be approximate and tentative, given the precarious
equilibrium in financial markets. As best we can
estimate, holding net borrowed reserves in the $100-$150
million range until mid-December would be likely to be
accompanied by some further upward creep in bill rates,
but perhaps with only minor implications for long-term
rates so long as market expectations do not change.
However, quoted CD rates are generally at their
ceilings, and further narrowing of the spread between
market rates and CD ceilings would make it difficult for
banks to replace the large CD maturities expected around
mid-December tax and dividend dates. If credit demands
on banks continue heavy, market pressures could intensify
in the final weeks of the year. Indeed, to hold close
to current rate relationships at that time may require
11/23/65
-32-
both increased provisions of nonborrowed reserves and
some increased flexibility for banks to compete for
funds.
If an assessment of the situation suggests the need
for increasing monetary restraint now, the flow of
nonborrowed reserves could be limited. The impact on
market rates of a deeper net borrowed reserve position
would likely be substantial and relatively prompt. The
rise in rates could be expected to pervade all maturities.
Expectations of a discount rate increase would reinforce
and perhaps make cumulative the upward pressure on market
rates, and the CD market would require immediate relief
if contraction in bank deposits were to be avoided.
My own assessment weighs out in favor of the first
course of action. Given the knowns and the uncertainties
in the economic scene, domestic and international, the
case seems persuasive to me that present taut conditions
in financial markets are providing all the monetary
restraint needed at the moment, and the possibilities
are that these conditions will become even tauter before
year-end.
Chairman Martin then called for the go-around of comments
and views on economic conditions and monetary policy.
Mr. Hayes,
who spoke first, made the following statement:
The set of economic conditions on which our policy
must be based is largely unchanged since three weeks ago.
Such minor changes as have occurred in the over-all
economic picture have tended to confirm even greater
strength in the domestic economy than at the time of our
last meeting and an even less satisfactory balance of
payments situation than was apparent at that time.
Finally, it is becoming ever clearer than artificial
rigidities in the interest rate structure are handicap
ping the efficient flow of funds in the economy. In my
judgment the time has come for monetary policy to make
a significant further contribution to more balanced and
sustainable growth in the domestic economy and a
strengthening of the dollar's international standing.
I recognize that the Treasury is in the process of
completing its November financing schedule, but I
believe that we are at last able to reach policy
11/23/65
-33-
decisions without the constraint of even keel considera
tions. The November refunding is pretty much out of the
way, and while distribution of the tax anticipation
bills, for which payment is due tomorrow, is not completed,
this is not enough to be a major deterrent to action on
our part. I might point out also that with additional
Treasury financing probably due to be announced sometime
between mid and late December, the period in which we
are free to act will not last very long.
With respect to the domestic economy, the longer
term outlook remains strong, and business optimism seems
more firmly based than a few weeks ago. The prospective
buoyancy of plant and equipment spending is especially
impressive. Incidentally, I can see no ground for fear
that the recent disparity between rates of output growth
for capital and consumer goods has meant a tendency toward
overbuilding of capacity. On the contrary, plant
utilization rates have risen very appreciably since 1961,
despite large additions to capacity, and seem to have
remained about unchanged in 1965. With the likelihood
that GNP will be growing at a rate of around $11-12
billion per quarter in 1966, the gap between actual and
potential levels of activity will probably narrow further;
and this should mean continued pressure on industrial
capacity and on the labor market. The over-all
unemployment rate over the year ahead is, at worst,
likely to be no higher than the October 1965 figure of
4.3 per cent and may well decline below 4 per cent. If
so, increased shortages of skilled and even other workers
will probably develop, and wage rates may be subject to
excessive upward pressure. Economic prospects also seem
conducive to price increases, despite the prospect of
further productivity gains and the Administration's
recent strong stand in opposing price increases by means
of the guideposts and moral suasion. There is always a
risk too that the course of events in Vietnam might
intensify the stimulus provided by rising Federal
outlays.
Our international problem remains decidedly serious,
with balance of payments statistics continuing to make
disappointing reading. The October deficit is estimated
around $300 million and our November weekly indicators
still register deficits of varying magnitudes. Prospects
are that the regular deficit for 1965 will exceed $1.8
billion and may possibly be as high as $2 billion.
11/23/65
-34-
Changes in the method of reporting the deficit cannot
conceal the fact that our accounts are still badly out
of balance, even after allowing for the fact that
liquification of British security holdings tended to
amplify the deficit. Moreover, the "official settlements"
balance for recent quarters is almost meaningless in the
light of the very large foreign exchange operations of
the Bank of Italy, carried out with the cooperation of
the U.S. authorities. The weakness of our payments
position is especially worrisome at a time when we are
commencing difficult negotiations on the future of
international financial arrangements.
Turning to credit developments, we find that bank
credit showed renewed and pervasive strength in October
after a weak September. In the first ten months of 1965
bank credit was growing at the rate of 9.7 per cent per
annum, well ahead of the 1964 rate. While there has
been some slackening in business loan growth since
mid-year, as corporations were able to tap other sources
more effectively, there has been renewed strength in
early November, and most banks look for continuing
strong general loan demand. Money supply and time
deposits grew in the first ten months at an annual rate
of 9.6 per cent, as compared with 7.9 per cent for all
of 1964. An examination of broader indicators of credit
growth reveals that while banks accounted for a larger
share of the total than in 1964, there was also a
substantial rise in the rate of total credit growth.
Reduced corporate liquidity, combined with the prospect
of heavy business spending, points to the likelihood of
further heavy demand for credit from all available
sources.
A final factor of great importance is, as I mentioned
at the last meeting, the distortions in the interest rate
structure resulting from a combination of heavy credit
demands throughout the maturity range and rate rigidities
introduced by regulatory or statutory ceilings and
political pressures. For example, now that the leading
city banks are paying the ceiling rate on 3-month
certificates of deposit, any further upward movement of
market interest rates could bring a severe loss of bank
deposits and a consequent shrinkage of bank assets. The
prime rate, which has become a favorite subject for
political attention, is out of line with rising rates in
the corporate bond market and with the rising cost of
11/23/65
-35-
The 4-1/4 per cent ceiling on the
money to the banks.
coupon rate applicable to new Treasury bond issues is
now proving to be a major obstacle to the continued flow
of savings into the Treasury. And fin.lly, the discount
rate is becoming more and more out of line with market
rates of interest.
In my judgment this combination of circumstances
points to a clear policy conclusion. The time has come
for an overt move to signal a firmer monetary policy,
and an increase in the discount rate by 1/2 per cent is
the appropriate means of effecting such a change.
It
seems to me imperative that the System take this action
to lend additional support to the voluntary foreign
credit restraint program. That program may well prove
increasingly difficult to administer in the absence of
such additional support, and in any case it is not too
early to be striving for a more basic improvement in
our payments position. Not only is the economy amply
strong to withstand any effects of firmer interest rates,
but we are probably very close to the point where continued
sustainable domestic expansion depends on greater effort
to keep inflationary pressures under control--and of
course this is of vital importance in connection with
the maintenance of a large external trade surplus.
In
view of these considerations, it seems no more than
prudent to try once again to slow the recent excessive
Finally: a discount
rate of bank credit expansion.
rate increase, with an accompanying increase in Regula
tion Q ceilings, would permit greater reliance on market
forces an interest rates in channeling the flow of
funds.
Most of the directors of the New York Bank have
felt
for some time that an increase in the discount rate
is overdue.
Indeed, on a number of occasions some of
them have urged that the Bank take the initiative in
this area.
I am now prepared to recommend that they
vote a 1/2 per cent discount rate increase within the
next week or so.
As for open market operations, it seems to me that
we would be well advised to avoid any significant change
until we have had time to observe the effects on the
market of a discount rate rise. An overt change in
System policy before the end of the year is apt to come
as something of a shock to the market. While the
technical position of the market is much better than a
-36
11/23/65
month or so ago, we have to be prepared for a rather
strong initial reaction to a discount rate change. No
doubt market interest rates will move higher, and I
believe it would be wise, for the time being at least,
to keep reserve availability about unchanged while
meeting the seasonal reserve needs expected in the weeks
ahead.
I think the Manager should be allowed fairly
wide discretion to keep the market adjustment as orderly
as possible, and we should be prepared to tolerate some
increase in net reserve availability i. this turns out
to be necessary.
For the moment I should think we
might instruct the Manager to maintain about the same
money market conditions as have prevailed in the past
three weeks. Accordingly, draft directive A, as
proposed by the staff, seems quite satisfactory, except
that I would add the words "reflecting strong credit
demand" after the words "firmer financial conditions."1/
Mr. Ellis reported that the Boston Bank's regular business
outlook conference last week confirmed, as expected, the standard
forecast of continuing GNP growth at about $10 billion per quarter
through next June.
Among the varied reports,
two items drew his
attention as evidence of the narrowed margin of unemployed resources:
an aircraft corporation was attempting to expand its
Hartford work
force by 1,000 persons per week for 8 weeks; another Connecticut
employer was offering a $50 "finder's
fee" to present employees
for each new worker hired as a result of their personal recruiting
efforts.
Another conference participant indicated that insurance
company current commitments were running at 93 per cent of cash
1/ The two alternative directives suggested by the staff are
appended to these minutes as Attachment A.
11/23/65
-37-
flow--a record high for the industry.
In anticipation of further
needs for funds, a larger number of companies had established lines
of credit at commercial banks, a number of which had not been used
as yet.
In Mr. Ellis' judgment, it would be difficult to fault the
economy and its progress when appraising it in real terms.
Real
growth was substantial, but not so rapid or distorted as to have
caused production bottlenecks.
Expansion and modernization was
being concentrated where capacity was tightest.
been and continued to be reduced.
Unemployment had
The outlook was universally
conceded to be for further such growth, with no widespread
convictions that rapid price inflation was inevitable.
Economic
strength seemed firmly based, not weakly balanced.
When described in financial terms, however, the current
picture was less reassuring.
It was difficult to feel secure when
the money supply was expanding at 7.6 per cent (on a three-month
average) while GNP was expanding 4.7 per cent in real terms.
Even
given the substantial expansion of intermediation by commercial
banks, it was disturbing to contemplate a 20 per cent year-to-year
increase in business loans, against a 9 per cent parallel gain in
industrial production.
Without being able to measure the degree, Mr. Ellis said,
it was nevertheless apparent to him that the quality of credit
-38
11/23/65
extended had declined.
Without being able to assess its full
potential, it was evident that banks had greatly reduced their
liquidity and their capacity to withstand financial shock.
While
the balance of payments had improved over the past year, it was
evident that further measures would be requ:.red to restrain
capital outflows.
One such measure, a move toward lesser ease
would not only buttress the special credit restraint measures
being employed but would serve as a widely understood monetary
signal that would strengthen the willingness to hold dollars
abroad.
Mr. Ellis said he used the phrase "lesser ease" because in
retrospect the record suggested that the Federal Reserve had eased
its reserve availability and allowed an accelerated expansion of
reserves while limiting rate increases.
Member bank borrowings
averaged in excess of $525 million each month between June and
September.
In October they averaged $490 million, and they
averaged $438 million for three weeks of November.
After declining
in August and September, nonborrowed reserves expanded at a 5.5
per cent annual rate in October and at about a 6 per cent rate in
three weeks of November.
Meanwhile, 3-month bill rates, which
rose 8 basis points in September and 10 basis points in October,
had been held to a 5-point rise in November.
Concern that higher
bill rates would force a discount rate increase had tended to
11/23/65
-39
translate a "voluntary" prime rate ceiling of 4-1/2 per cent into
a 3-month bill
rate ceiling of 4.10 per cent.
Looking ahead,
the historical
however,
the Committee must contend with
fact that in years of strong credit demands bill
rates normally rose 8 or 10 basis points in response to seasonal
pressures alone in
the next several weeks.
In Mr.
Ellis'
judgment,
the Committee should not pour out reserves in an effort to enforce
a rate ceiling against seasonal pressures.
While it could quite
properly seek to insure that rate movements did not become
disorderly, it should not seek to enforce a ceiling at any level.
The result would be to destroy the market's ability to set its
own
rates and the Committee's ability to judge true demand and supply
relationships in
be left
the market.
Interest rates were too important to
to arbitrary judgments from any source.
At the meeting yesterday of the Boston Bank's directors,
Mr. Ellis said,
he took the position that this was not the proper
moment to raise the discount rate.
Member bank borrowings were
running lower than for any month since March.
stabilized in recent weeks.
Bill rates had been
Business loan demand was just about
meeting seasonal expectations.
Mr.
Ellis said that although he agreed with Mr. Hayes'
analysis, he would reverse the sequence of moves.
on reserves first and the discount rate later.
He would move
His choice would
-40-
11/23/65
be to restore reserve objectives to primary positions as targets
of policy.
Now that the Treasury financing schedule had been
completed for the year, it should prove feasible to establish a
goal of moderate reserve growth associated with net borrowed
reserves averaging $150 million.
If demands for credit exceeded
seasonal patterns, the Committee should expect borrowing to exceed
$550 million and some tendency for short bill rates to rise to
4.20 per cent or higher.
The underlying philosophy of such an
approach was to throw onto the market the responsibility for
revealing the degree of pressure for credit expansion.
If higher
rates, including higher discount rates, were to eventuate, they
should result from increased credit demands against a steadily
growing reserve base.
Mr. Ellis said he was attracted to alternative B of the
draft directives.
However, what he had suggested in terms of
policy could probably be carried out equally well under
alternative A.
Mr. Irons reported that the latest estimates in regard to
Eleventh District economic activity continued to reflect expansion
and growth, particularly in the major areas of activity.
There
had been an increase in manufacturing output, both of durables
and nondurables.
The petroleum situation showed improvement, as
did the chemical situation.
Construction continued strong.
11/23/65
-41
Employment continued to set new records,
with increases in both
the manufacturing and nonmanufacturing sectors.
rate stood at 3.2 per cent.
good,
The unemployment
Automobile sales were exceptionally
and the agricultural situation was very strong this year as
compared with preceding years.
Bankers reported that the pressure for loans continued
unabated,
although the loan figures showed relatively little
change from the high levels that had prevailed.
In
fact,
the
banks had reduced their loans a bit in the recent period, while
disposing of some Governments and increasing their holdings of
other securities.
Although they were not borrowing from the
Reserve Bank heavily, they were active in the Federal funds market,
with substantial net purchases.
The discount window had about
cleared out the seasonal type of agricultural lending.
Those banks
that were now out of debt to the Reserve Bank might find it
or preferable
easier
:o go into the Federal funds market and come to the
Reserve Bank only when funds were not otherwise available.
The general attitude in the District was optimistic,
Mr. Irons said, although there was some degree of concern about
the inflationary potential.
On the national side, he agreed with
the data in the green book and the supplement to it.
His appraisal
of the material was that it confirmed the strength of the economy,
with continuing expansion on a broad basis.
He anticipated a
11/23/65
-42
substantial rise in final demand through the fourth quarter and on
into next year.
Most economic indexes seemed likely to rise further.
Demand was beginning to press on capacity, and cost pressures seemed
likely to increase as labor markets continued to tighten.
Money and credit markets reflected firmness, with demands
placing pressure on the supply of available credit.
Apparently
there was some uncertainty in the market as to the probable cost
and availability of credit, and perhaps as to the position the
Federal Reserve would take on credit availability.
This raised
the question whether a more positive position would be desirable.
This was the time of the year when seasonal pressures were present,
and in addition other influences had entered into the picture with
regard to rate levels and rate administration.
Mr. Irons said his thinking was somewhat along the lines
of that expressed by Mr. Hayes.
It seemed to him that there might
be some advantage in a confirmation of recent rate movements in
the market through a discount rate change.
dispel some uncertainties.
Such a move would
But he was not sure it would be
necessary to raise the discount rate to 4-1/2 per cent.
The
present market rate structure was roughly compatible with a 4-1/4
per cent discount rate, so a change in the rate to that level
would be a confirmation of the market rate structure and an
indication of the System's policy thinking.
Such a move might in
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11/23/65
the long run be more effective than either deferring a discount
rate change or taking a stronger action at this particular time.
This brought in the whole question of timing, considering the
atmosphere in which the Committee found itself and the framework
within which it operated.
He was not certain about those factors,
and he realized there were counterarguments to a course of action
such as he was suggesting.
Nevertheless, it might tend to quiet
uncertainties, confirm a position the market had taken, and
perhaps lesser the possibility of further substantial rate
increases.
Mr. Irons thought in terms of directive alternative B, but
he did not have strong feelings one way or the other.
Either A or
B of the draft alternatives would seem compatible with a policy
approach such as he had outlined.
Mr. Swan reported that employment ir the Pacific Coast
States increased somewhat in October in all sectors except
construction and mining.
But with the labor force growing the
unemployment rate remained unchanged at 5.6 per cent.
Employment
in defense-related manufacturing had improved slightly further.
Construction contract awards increased in September--the latest
month for which statistics were available--and for the first time
the cumulative figure for the year to date was above that of the
comparable period in 1964.
But the increase was only 1-1/2 per
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11/23/65
cent, compared with an increase of 4 per cent for the country as
a whole.
In the three weeks through November 10, total credit of
Twelfth District weekly reporting banks declined as the loan
increase was more than offset by a decrease in securities holdings.
However, the rise in commercial and industrial loans was consid
erably greater than at weekly reporting banks throughout the
country, representing a reversal for that period of the earlier
relationship.
Even so, the reserve position of the Twelfth
District banks in recent weeks had been relatively easy, and their
borrowings from the Reserve Bank had been extremely low.
In terms of the national picture, Mr. Swan was inclined to
agree with the analysis in the green book.
The situation was not
appreciably different than at the time of the last meeting of the
Committee, but it certainly remained a stron, one.
In terms of policy, Mr. Swan said, the situation was quite
difficult, but it seemed to him the Committee ought to maintain its
current posture.
He recognized that the need for overt action
might be somewhat closer.
Like Mr. Ellis, however, he was inclined
to think that the point had not yet been reached.
He noted the
relationships discussed in the blue book 1 / as between net borrowed
1/A document entitled Money Market and Reserve Relationships prepared
by the staff and distributed under date of November 19, 1965. A
copy has been placed in the files of the Committee.
-45
11/23/65
reserves and interest rates and the prospective basic provision of
nonborrowed reserves,
seasonally adjusted, at about a 2-1/2 per
cent annual rate for November.
If those relationships continued,
the Committee could live with the situation.
However, he agreed
with Mr. Ellis that emphasis should be placed on the provision of
reserves to take care of seasonal needs.
If credit demands should
turn out to be considerably stronger than seasonal,
so that there
was some reflection of those pressures in market rates, the
Committee would be faced with the question of what action to take.
But the situation should be allowed to develop first.
He would
stay for the moment with net borrowed reserves of $100-$150
million rather than to raise the sights slightly in those terms.
Consequently, he would accept alternative A of the draft directives.
Mr. Galusha said all indications were that economic activity
in the Ninth District was continuing to expand at a satisfactory
rate.
Orly about the construction industry could there be
pessimism.
With the dollar value of contract awards down sharply
from a year ago,
the industry's immediate future was not exactly
bright with promise.
Otherwise,
however,
intelligence was decidedly encouraging.
current economic
Although the dollar
figures showed a significant expansion, the ratio of classified
loans was more favorable than for the preceding two years.
No
major price shifts had come to his attention except in the area of
packaging materials.
-46
11 23/65
As for the national economy, a bearish cast could be put
on some recent economic news.
For instance, it could be argued
that next year's revision of the November 1965 McGraw-Hill plant
and equipment spending forecast would not be anything like the
revisions of 1964 and 1965--the reason being that this November's
accompanying sales forecast seemed so much nore reasonable than
those made in November 1963 and, even more, in November 1964.
And
it could be argued--on the basis of recent auto sales--that the
industry would not do quite as well in 1966 as it did in 1965.
Yet the fact remained that it was difficult to make the outlook
for 1966 anything but bullish.
That apparently was the most prudent
assumption upcn which to base current decisions about monetary
policy.
The issue, therefore, was whether ccming quarters would
not find business a shade too good.
In that connection, the
information about the behavior of money wages and industrial prices
contained in the green book was encouraging.
So was the staff's
judgment that a fourth quarter increase in GNP of $10 to $12
billion would not change the average utilization rate or, presum
ably, bring on an acceleration of the moderate price creep that
had been experienced.
Mr. Galusha observed that evidently no one was expecting
an average quarter-to-quarter increase in GNP for 1966 of more
11/23/65
-47
than $12 billion.
The most optimistic forecasts, which by the way
probably did not take full account of the most recent increases
in long-term interest rates, implied something rather less than
this average increase.
Thus, however justified the recent
increases in interest rates were, and however justified the recent
unwinding of "operation twist" was, further increases in rates
might be unwarranted unless the stand was taken that an increase
in prices, even if extremely modest and not at all likely to
accelerate, should not be permitted.
Nor, Mr. Galusha continued, could an increase in the
discount rate be accepted as merely a technical adjustment.
There
was no basis, whether in theory or experience, for thinking that
If
such an increase would leave open market rates unaffected.
there were circumstances in which that could happen, they were
not those of today.
The thought that an increase in the discount
rate would not bring on an increase in bank loan rates--the prime
rate included--was hardly credible.
Such an increase might be
desirable, but if so the bankers ought to be able to bring it off
without help from a "price leader."
Finally, Mr. Galusha said, recent developments suggested
that financial markets now believed current rates to be maintain
able, so an increase in the discount rate no longer appeared
"necessary," if it ever did.
11/23/65
-48
He would be less than candid, Mr. Galusha commented, if
the impression was conveyed by his comments that he was not uneasy.
His hunch was that the Committee was approaching a moment of truth.
Hunches were an important part of professional decision making,
but not until experience justified some credibility.
Without that
experience he must rely on such evidence as came to hand, and the
evidence did not appear to warrant a significant change in policy.
Of the expressions he had heard thus far, he was inclined toward
those of Messrs. Ellis and Swan that within the range of the
present directive the Committee could probably exercise adequate
restraint, at least for the ensuing period.
This would mean that
any unusual demand, over and above that which could be predicted
on a seasonal basis, should be dampened.
Mr. Scanlon reported that the economic atmosphere in the
Seventh District could be characterized as ebullient.
Activity
was at a high level and was expected to rise further.
There were
frequent reports of bids on new commercial, industrial, and public
construction projects coming in far higher than anticipated and,
in some cases, of a reluctance of contractors to negotiate firm
prices.
Structural steel fabricators were said to be overbooked.
Perhaps the most significant development of recent weeks
concerned a further tightening of labor markets despite the
reduction in steel output.
In September estimated unemployment
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11/23/65
rates in District States ranged from 1.3 per cent in Iowa to 2.6
per cent in Illinois and Michigan, compared with 3.8 per cent
(unadjusted) for the United States.
Insured unemployment rates in
the District at the beginning of November ranged from 0.7 per cent
in Iowa to 1.2 per cent in Illinois, compared with 2.1 per cent
for the United States.
For Indiana, the District's largest
steel-producing State, the rate was 1.1 per cent, compared to
about 1.5 per cent a year ago.
Employers were making vigorous
attempts to recruit workers, and reports of labor pirating were
heard frequently.
Steel production in the Seventh District had been about
level since the middle of October.
It was believed that the next
turn would be upward, although the uptrend would not be appreciable
until after the turn of the year.
Some selective steel price
increases had occurred, principally affecting specialty items and
smaller quantities sold through warehouses.
The financial indicators confirmed the buoyant business
conditions, Mr. Scanlon said.
Although the growth of business
loans at Seventh District banks had slowed somewhat in recent
weeks, due primarily to repayments by durable goods manufacturers,
the increase for the year to date remained well above all recent
experience and slightly greater than the record increase for the
country as a whole.
After adjusting for the temporary intake of
11/23/65
-50
the new tax anticipation bills in October, District banks had
continued to liquidate Treasury securities and gave evidence of
becoming less aggressive in purchasing other securities.
They
continued to make less use of the discount window than in past
periods of similar rate relationships.
In the absence of a change
in Regulation Q, reserve pressures on the banks might be expected
to increase, culminating on the December corporate tax date when
a large volume of CD's was scheduled to run. off.
As to policy, Mr. Scanlon said that, like Mr. Ellis, he
would not want to resist a modest seasonal rise in rates by
invoking a rigid rate objective in the coming period.
He would
defer any change in the discount rate, although he believed there
was considerable merit in Mr. Irons' suggestion.
For the immediate
future, he favored a policy that would imply slower growth in money
and credit and, assuming continued strengthening of credit demand,
modestly higher interest rates.
If market forces pressed in that direction, he would expect
that in view of seasonal pressures the 3-month bill rate would rise
somewhat further, perhaps as high as 4.15 or 4.20 per cent.
He
would hope that it might be possible to ride with such a policy
during the remainder of 1965 and through the early weeks of 1966
while observing economic developments and getting a better line on
Federal budget prospects.
He continued to feel that any considera
tion of an increase in the discount rate must be accompanied by
-51
11/23/65
consideration of an increase in the rates banks were permitted to
pay on time deposits.
While he could accept alternative B of the
draft directives, he believed that a policy such as he favored
could be carried out under alternative A.
Mr. Clay commented that the national economy continued to
expand faster than anticipated earlier and its prospective perform
ance also appeared to exceed earlier expectations.
There was little
evidence to suggest any lessening of economic activity in the months
ahead; rather it appeared to be a question of the degree of
advancement.
Except for residential construction, activity in all
major sectors of the economy was increasing.
The scale of
prospective Government spending, notably defense outlays, remained
of unknown proportions, but military developrents strongly suggested
that that factor would be expansive beyond present indications.
The remarkable growth in the economy that had taken place
had been accomplished in essentially an orderly fashion in terms
of resource utilization and prices, as manpower and other resources
generally had been available and prices had not experienced a
marked breakthrough.
With the margin of unutilized manpower and
other resources smaller than earlier, however, prices were more
sensitive than heretofore.
Resource utilization could be expected
to continue to grow and, despite expanding resources, the margin
of unutilized resources probably would narrow still further in the
months ahead.
-52
11/23/65
As the shape of those forces would have to await further
developments, Mr. Clay felt that monetary policy could justifiably
continue essentially unchanged for the present in terms of money
market conditions and reserve availability on a seasonally adjusted
basis.
Looking further ahead, there was ample reason to wonder
whether money and capital market developments might not make the
present discount rate and the current degree of reserve availability
incompatible.
In that event the Committee would need to choose
between higher money market rates with current reserve availability,
the present level of money market rates with increased reserve
availability, or some other combination of those alternatives.
Mr. Clay thought the decision would have to be made on the
basis of the economic situation then existing, so as to facilitate
potential economic growth within an orderly framework.
It was
likely that the appropriate course of action would depend on the
impact of Government defense spending on the economy.
Defense
spending had been a significant force in the economy for several
months.
Should the scale of that program be materially increased,
the economy's balanced economic growth might be seriously disturbed.
Alternative A of the draft directives appeared to Mr. Clay
satisfactory at this time, and he did not think that a change
should be made in the discount rate.
11/23/65
-53
Mr. Wayne reported that Fifth District business continued
to improve and showed evidence of acceleration in some sectors.
Not a single respondent in the Richmond Bank's latest survey
expected business to decline in the near future.
Manufacturers
in the survey reported increases in orders and shipments, and about
one-third reported higher wages and prices.
The textile industry
had experienced a resurgence of new orders following passage of
the farm bill.
board.
Labor markets appeared to be tightening across the
Shortages had become especially acute in the coal industry,
causing some recent cutbacks in scheduled deliveries to utilities,
and one coal producer reported that some contracts for spring
deliveries included price increases of 15 to 25 cents per ton.
Meanwhile, the national economy continued to show moderate
gains from high levels of activity.
Substantially all of the
changes in October were favorable, indicating that the effects of
lower steel production were more than offset by strength in other
sectors of the economy.
Additional reports of labor scarcity and
the rise of overtime in manufacturing in October indicated that
the pressure on manpower was rising.
The production of business
equipment continued to follow a spectacular course and to pull
farther and farther ahead of the production of consumer goods.
Since December of last year the production of equipment had risen
nearly five times as fast as the production of consumer goods.
-54
11/23/65
With the prospect of high and rising outlays on equipment next year,
it would seem that there was a real possibility of a serious
imbalance between productive capacity and the output of consumer
goods.
In the international area, Mr. Wayne continued, the threat
to sterling now appeared less acute than at any time in recent
months.
Some of the recent improvement had come, however, at a
cost to the U.S. balance of payments.
Estimates of the deficit
since July were especially discouraging in view of the fact that
the deficit was experienced despite the voluntary credit restraint
program and the interest equalization tax.
There were some indications that the seasonal demand for
credit for
the remainder of the year might not be as great as
expected earlier.
If this was correct, the Committee might be able
to get by for the rest of the year without further measures of
restraint.
In Mr. Wayne's judgment, that was greatly to be desired
if it was feasible, since any substantial firming would require
action on the discount rate and bring additional pressure for an
increase in Regulation Q ceilings.
He did not think that the System
should resort at this time to an overt action, such as an increase
of 1/2 per cent in the discount rate, designed to produce a sharp
impact on expectations.
-55
11/23/65
Mr. Wayne felt the Committee had limited room for maneuver.
It would not appear that the Committee could seriously consider any
easing of credit.
On the other side, any substantial tightening
would intensify several very thorny problems.
Discounting would
increase and many banks might face a shortage of Governments to
use as collateral.
The market would anticipate an increase in the
discount rate and general increases in prevailing rates would make
it difficult to avoid such a move.
The most immediate effect of
higher market rates would be to endanger the CD position of money
market banks and probably precipitate a drop in the long-term
markets.
The raising of Regulaticn Q ceilings would not be an
adequate solution to the problem since such a move in itself would
promote bearish expectations.
In brief, any significant move
toward firmer credit would carry a strong implication that the
discount rate would be raised soon, and he was not ready to take
that step yet.
His preference would be to continue present policy,
and he fo nd draft alternative A acceptable as a directive.
Mr. Robertson made the following statement:
The last three weeks have provided us with more
confirming evidence that we should go no further in
tightening monetary policy at this juncture.
On the price front, the gradual upcreep in the
general industrial commodity index has slowed down, and
certainly the latest aluminum and copper price rollbackswhatever their broader social implications--will give a
little more pause to any other administered price
increases that might have been in the offing.
11/23/65
-56-
In financial markets, conditions also seem a little
better balanced. Perhaps the most constructive thing
that has happened is that market expectations of an
imminent discount rate increase have been quieted some
what. In this calmer atmosphere, funds seem to be
flowing fairly well through both the money and bond
markets. I see no evidence of any "knots" that need
untying by official action.
In the next few weeks the seasonal pressures in the
money market will mount to their usual annual peak. If
feasible, I would like to avoid allowing such technical
pressures to force us into a basic change of monetary
policy that might more appropriately wait until the
impact of next year's Federal budget can be judged.
Some bankers have been insisting that something must be
done to resolve interest rate and Regulation Q ceiling
questions before the December squeeze, but I think the
availability of the Federal Reserve discount window and
the Board's capability of revising pertinent Regulation
Q provisions quickly, if necessary, combine to give any
well-run bank all the safety valves it ought to need
for this period. This particular CD squeeze does not
seem to me to be the kind of development that should be
dealt with by general monetary policy. That, I maintain,
should be addressed to the broad performance of the
economy, which I regard as too strong to warrant any
easing, but not yet so clearly inflationary as to call
for further tightening.
Our directions to the Manager, therefore, should be
to walk a tightrope between now and year end, keeping
money market rates as a group from either rising or
falling significantly, and letting net borrowed reserves
move where necessary in order to preserve such a money
market tone. I would vote in favor of alternative A of
the draft directives submitted by the staff, and would
hope the Manager would interpret it in the same way as
he interpreted the similar directive over the three
weeks just past. My views on the discount rate are
already known to the Committee from my comments at the
last meeting, and I have had no reason to change them.
Mr. Shepardson commented that every available indication
pointed toward a strengthening economy.
Not only were people
talking about good business the rest of this year and in 1966 but
11/23/65
-57
some recent statements projected a continuing rise in 1967.
He
thought there was clear evidence of increasing over-expectations,
and that the rate of money growth and credit expansion was clearly
beyond sustainable levels.
The Committee had spoken for some time
in its directives about a moderate growth, but it did not seem to
him that the present rate of expansion could be defined as moderate.
There was concern about what the Federal budget would be,
Mr. Shepardson noted.
He had no knowledge of what it would be,
except that programs already inaugurated were inevitably going to
call for more spending.
As far as military expenditures were
concerned, it seemed inconceivable that with the type of conflict
the country was going into those expenditures would not pick up
significantly.
The reports around the table, Mr. Shepardson pointed out,
all indicated an increasing shortage of labor, and that was bound
to bring pressure.
Notwithstanding the position being taken by
the Administration on certain selected prices, the general pressure
of demand on prices would be inevitable.
He found it difficult to
accept the approach of waiting until the horse was out of the barn
before locking the door.
be gotten back down.
Once prices went up, they could hardly
Higher prices would not improve the balance
of payments situation, nor would they improve the prospect of
long-run economic growth.
11/23/65
-58
It seemed to Mr. Shepardson that all indicators showed
sufficient strength in the economy to withstand some restraint.
The Committee had been putting off such action until everyone could
point to clear evidence in the figures as to what had happened.
Personally, he thought it was time to let up on the gas pedal and
put on the brakes; in other words, it was time to be moving toward
a little more restraint.
He was aware of the seasonal demands and
would want to neet them, but he would meet them reluctantly, with
the result that there might be some increase in negative free
reserves to between $150-$200 million.
If seasonal demands were
as strong as appeared likely, this probably would result in some
further pressure on the discount rate, and he would expect a move
on the discount rate to be called for in the near future.
When it
came to the change in the rate, he did not think an increase of
1/4 per cent would settle the matter.
If the System was going to
move, it might just as well move the rate up 1/2 per cent and give
itself leeway to operate for some time into the future.
Mr. Shepardson favored alternative B of the draft directives.
He believed that the Committee should try to check the pace of
monetary expansion a little if it meant what it said about promoting
sustainable growth.
He also felt that the System should be
prepared for a discount rate increase in the near future.
Mr. Mitchell said the economy was performing better than
he had expected it would at this point, and as well as he had hoped.
11/23/65
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The possibility of a downturn due to the effects of the steel
adjustment. seemed to have been removed.
His general views about
the economy were quite well summarized in the chart show.
At the moment, Mr. Mitchell did not see a threat to
stability in the present and prospective rates of resource utiliza
tion.
Therefore, he saw no basic reason for any further firming
action on the part of the Committee at this time.
Possibly there
would be some disclosure when the Federal budget was presented
that would provide a clue for action, but in the meantime he would
supply reserves adequately and ungrudgingly to cover seasonal
requirements reasonably related to the present level of GNP.
He
hoped that this course would be adequate to get through the rest of
the year.
Mr. Mitchell said the requirement from the standpoint of
the balance of payments was to contain inflation within the U.S.
More should not be expected from monetary policy.
necessary to go beyond that, selective
If it was
easures should be used;
he would not want to take measures that would restrict the domestic
economy generally.
It seemed to him the information in the chart
show suggested quite persuasively that the price rises that had
taken place were not pervasive.
They were not the type that
resulted from excessive demand.
For those who were worried about
the money supply growth, he would point out that this year there
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-60
had been no change in turnover in New York, and little change in
the other six main money centers.
In this situation there was only
one change that could occur--the money supply had to grow.
Mr. Mitchell agreed with Mr. Hayes that the rate pattern
had been distorted for some time.
He hoped that before too long
these distortions could be more or less unraveled.
But he would
not like to see this done in a period when there were seasonal
pressures on the whole rate structure.
The Committee had lived
with the distortions for a long time, and he hoped in the year
ahead something could be done, but not right now.
For that reason
he would reject Mr. Irons' proposal, although he found it quite
attractive in a way.
Perhaps something of that kind should be
done in January, if the Committee did not find it necessary to do
something else, but he would reject such a course of action at this
point, largely for the reasons Mr. Galusha had advanced.
Mr. Mitchell favored alternative A of the draft directives
but propos d certain language changes.
At the beginning of the
first paragraph, he would say: "The economic and financial devel
opments reviewed at this meeting indicate that over-all domestic
economic activity is continuing a rate of expansion comparable to
that of the third quarter despite the contractive effect of a
reduction in steel inventories.
Business sentiment continues
optimistic and financial resources are in shorter supply,"
This
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11/23/65
would call attention to the fact that the contractive effect of the
steel inventory adjustment had been absorbed and the economy
continued to grow at the same rate as before.
Mr. Daane commented that three weeks ago he was pretty well
convinced that once the Treasury financing was out of the way the
time had come for an overt move in System polLcy involving a change
of 1/2 per cent in the discount rate and in Regulation Q ceilings
coupled with some cushioning of the move,
in
similar to last November,
terms of somewhat greater reserve availability initially.
His view had been premised on both economic and financial
grounds.
From the standpoint of the economy,
the System had for
several years been following--in his judgment appropriately--a
relatively easy, or more or less passively accommodative, policy
in
order to provide the needed credit stimulus or support to
increasing aggregate demand in the interest of achieving full
employment and a sustainable expansion within the framework of
relative price stability.
On the resource utilization side,
and specifically the
employment side--or more accurately the unemployment sideMr. Daane now felt that, as had been publicly acknowledged by top
Labor Department officials, the country was down to the hard core
unemployment,
or a composition of unemployment that might be
relatively impervious to additions to total aggregate demand.
11/23/65
-62
Further credit-stimulated additions to demand in current circumstances
of close to capacity operation in terms of utilization of resources
must inevitably risk accelerating a price upcreep--perhaps even
upsweep--that he sensed was already in process.
Continuance of a no-change System policy risked overstimula
ting an investment boom rather than containing it in the interest of
continuing a sustainable expansion.
On that score, in reading the
green book and in following the chart show this mornirg, he again
was particularly impressed by three points which seemed to him to
be central to a diagnosis of the present situation.
First, business
fixed investment plans for 1966, which were already buoyant, at 8
per cent above 1965, were practically certain to be revised upward
if the general expansion continued.
Second, if business investment
outlays rose considerably faster than they were now projected to
rise, there would likely be fairly severe pressures on capacity in
the machinery industries.
And third, if GNP rose much faster than
it was now projected to rise, the "selectivity" that had been
characterizing price increases might begin to disappear, if it was
not already disappearing.
At some time further ahead--Mr. Daane hoped a long time
ahead--the risks and dangers of a downturn in business investment
were bound to be serious.
And the severity of the problem at that
time would depend directly on the degree of disproportion that had
11/23/65
-63
been allowed to develop in the meantime between the rate of growth
of capital expenditures and the general rate of growth of the
economy.
The degree of ease in monetary and credit policy would
certainly be a major determining factor.
Parallel to the need for restraining credit expansion so
as to help avoid an unsustainable acceleration in business
investment, restraint was needed to damp down the growth in
consumer expenditures financed by credit.
Here again the need was
for maintaining reasonable balance in the economy, and reasonable
sustainability of rates of increase in the various flows of
expenditure.
Above all, Mr. Daane said, it was necessary to restrain
credit expansion so as to retain a reasonable degree of price
stability.
Whatever set of theories of linkages between credit or
money and prices one might prefer, the present and prospective
situation was certainly one in which too much ease would be likely
to contribute, directly or indirectly, to upward pressures on
prices.
And if prices were to begin rising in a less selective
manner than apparent up to now, the price rise in turn would feed
the bullishness of the economy, stimulate protective inventory
investment, and accelerate capital outlays--in short, lead into a
classical boom completely unlike the steady well-balanced
expansion that had existed for nearly five years now.
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-64
Last, but by no means least, on Mr. Daane's list of economic
reasons for a System policy change was the deterioration in the U.S.
balance of payments, which was not entirely papered over by changing
definitions and strenuous Governmental efforts to achieve postpone
ment of some scheduled outflows into next year's statistics.
While
the effect of a policy change might not produce immediately
beneficial effects, it would clearly over time be supportive of the
current efforts.
Most importantly, it would contribute to the
relative price stability essential to the eventual resolution of
the balance of payments problem.
In sum, the case on economic grounds for a discount rate
increase this December appeared to Mr. Daane to rest on the
following:
1. Persisting gradual upward price pressures--with
the wholesale price index rising at an annual rate of
1 per cent. since June, following a 2 per cent rate of
rise over the previous 9 months.
2. Continuing rapid expansion of business fixed
investment at a pace disproportionate to the rise in
final products--in the past 10 months, business equip
ment production was up 10 per cent; consumer goods
production up 2 per cent.
3. A shrinking margin of unused resources--average
manufacturing output at 90 per cent of capacity (and
more in lines other than steel) and unemployment down
to 2.9 per cent of adult males, with signs of a
beginning slowdown of productivity and rise in unit
labor cost.
4. A persisting balance of payments deficit--at
roughly a $400 million per quarter rate on a regular
transactions basis.
11/23/65
-65On the financial side, Mr. Daane said that three weeks ago
he found the case for a change even more compelling.
Both the
demand and supply of funds seemed to be distorted by the contin
uance of relatively fixed rates in the banking sector and by the
Committee's policy of seemingly resisting market forces in the
interest of Treasury financing considerations.
Today, financial
developments still supplied support for a rate increase, although
perhaps somewhat less support than a few weeks ago:
1. Credit demands were large and growing, especially
business demands for external financing partly to pay
for disproportionate expenditures on fixed investment.
2. Despite big business capital market flotations,
and some bank efforts to push more borrowers into the
capital markets, a stable 4-1/2 per cent prime loan rate
kept drawing in business loan demands. To the extent
that resultant demands taxed bank resources, resultant
rationing actions pressed most against newer and smaller
borrowers.
3. Seasonal pressures would be pushing up bill
rates between now and mid-December--perhaps to in the
neighborhood of 4.15 per cent on the 3-month bill. An
accompanying seasonal tightening of other rates would
increase pressures on discount administration and might
trigger new disturbing uncertainties concerning discount
rate action.
4. Higher short-term market rates would squeeze
hard on bank ability to sell CD's to replace big December
maturities.
Such maturities were by now probably as big
as September, when the post-tax-date squeeze pinched
banks for several weeks and led to sharp rate run-ups.
5. Prime-name banks were already being led to
merchandise promissory notes at shorter maturities and
higher interest rates than allowable on CD's under
Regulation Q. Unless Q ceilings were raised, promissory
note issuance was likely to balloon in December, pushing
up rates and complicating the Treasury's intended turn
of-year bill financing. If promissory notes were
redefined as deposits to halt Regulation Q avoidance,
11/23/65
-66
Q ceilings would have to be raised to give banks relief,
and this would trigger renewed strong expectations of a
discount rate increase--expectations that could inhibit
market flows.
6. Higher interest rates could increase market
capacity to handle flows, as had happened in the cor
porate market in the past two weeks. A higher discount
rate could clear the air and improve the reception for
unexpectedly large Treasury financing needs in January.
That would be particularly true if at the same time
open market operations reduced somewhat the need for
member banks to borrow.
While Mr. Daane still felt the case could be made along the
lines he had indicated, he was today less certain about the timing
and sequence of System actions.
It seemed to him the market was
now poised precariously, having been buffetec by oral suasion and
shifting expectations to the point where an overt move in the form
of a discount rate change might set off a chain of over-reactions
that could go far beyond the sort of modest tightening he had had
in mind.
Thus, where he came out was that the Committee faced a
choice of two courses.
First, it could move back on net borrowed
reserves to the high side of the $150 million mark and accept, not
resist, market forces that in all likelihood would produce somewhat
higher rates in the days and weeks ahead.
Under that course he
would at that point consider a change in the discount rate.
To be
specific, following that particular course at this juncture argued
that it would be better for the System to follow than to lead the
market.
The alternative course was to go ahead with an overt move
11/23/65
-67
on the discount rate as quickly as possible, with the cushioning
action on reserves he had already suggested.
Those two courses
might not really be far apart in point of time, but his own
preference would be, he believed, to follow rather than lead the
market.
On the directive, Mr. Daane said that while philosophically
he would favor alternative B of the draft directives, he could live
with alternative A, provided somewhat firmer market conditions
were restored along the lines he had advocated.
Mr. Maisel said he disagreed strongly with the first and
last parts of Mr. Daane's analysis.
He did, however, agree that
there was a major problem in the likelihood of market over-reaction.
He was pleased to see the feeling of both the Account Manager and
the staff that this was a period of balance both in the economy
and in the credit markets.
The present situation was dangerous
and worrisome because the economy was balanced at a high level of
employment and output, but it was a ve-y satisfactory level and
one that he hoped could be maintained.
He did feel, Mr. Maisel continued, that a real danger of
a sudden change in sentiment existed as a result of a misreading
of the Committee's intent.
This would cause the markets to react
far more than anyone considered desirable.
11/23/65
-68
It was fortunate at this time that a balance existed and
that the Committee had an opportunity to wait and see.
in policy was required.
No change
The main pressures appeared to be off
with respect to the price-wage situation.
The rising rate of
increases in industrial commodity prices had slackened off.
There
was no indication of any acceleration of growth in the near term
that would lead to a deterioration in wages or prices.
Even more important, Mr. Maisel added, was the fact that
the country was now in the midst of a national emergency or war.
Major industries had been asked, with no uncertainty in the request,
to hold the price line.
Without far stronger reasons than existed,
a move on the System's part at this time to help raise the price
of the major commodity it influenced--money--would be taken as a
sign that banks wanted to opt out of the national effort and that
the System approved of such action.
This would directly contravene
the Administration's request to labor, industry, and the banks to
hold the line.
It seemed desirable to him to hold to present policy based
on the actual price-wage situation, the national effort, and the
need to maintain the present level in expectations and sentiment.
The Manager should completely meet seasonal needs as they worked
out in the market.
Mr. Maisel concluded by saying that he opposed a discount
11/23/65
-69
rate change and that he supported alternative A of the draft
directives.
Mr. Hickman said it seemed to him the Committee had little
room to maneuver, even if it wanted to, insofar as policy action
today was concerned.
With the last Treasury financing of the year
still in progress, it would be highly disruptive to change policy
at this time, particularly since the new tax bills would have to
be redistributed by the banks and dealers.
Moreover, financial
markets contirued to be unstable, with the market for U.S. Govern
ment securities still highly sensitive to rumors and expectations.
So far as commodity prices were concerned, Mr. Hickman
felt that the chance of serious price inflation was now greater
than at any time in the past four years.
known that this would happen.
Bit it could not be
For one thing, the standard price
indexes, while drifting upward, had still not accelerated.
For
another, the increased capacity now coming on stream and the
increase in the civilian labor force (barring unexpected draft
calls) should reduce the likelihood of price inflation.
Insofar as overheating was concerned, Mr. Hickman believed
the key question was the Federal budget.
The normal revenue throw
off from an expanding GNP would permit a noninflationary rise in
Federal spending for defense and the Great Society on the order of
$5-$7 billion.
On the other hand, a budgeted increase on a GNP
11/23/65
-70
basis much beyond that would clearly be inflationary and should be
offset by tighter money.
Even aside from the Treasury's current financing program,
the situation thus came down to a matter of strategy and timing.
With the budget now being drafted, the possibility of tighter money,
and the assumed consequences, might be a major inducement to holding
the Federal budget to a sustainable noninflationary level.
As a
matter of fact, he suspected that in this period of final budget
decisions the fear of tighter money was a more effective policy
instrument than the actuality would be.
Mr. Hickman therefore recommended no change in policy at
this time, no change in the discount rate, and no change in Regula
tion Q.
There were all sorts of technical problems to be handled
between now and the next meeting.
In dealing with them he hoped
that the Manager would resolve doubts on the side of ease.
He
hoped also that the Manager would supply reserves through open
market purchases whenever feasible rather than through repurchase
agreements.
Be favored alternative A of the draft directives,
amended along the lines suggested by Mr. Mitchell.
Mr. Bopp recalled having noted three weeks ago that it was
becoming increasingly difficult for him to determine the appropriate
stance for policy.
Events since then and the outlook for the future
certainly did not make the determination any easier.
-71
11/23/65
Although the upcreep in prices had slowed and capacity
limitations still did not appear to block further gains in output,
many forecasts now emerging suggested a growth rate that could move
the economy very close to full employment levels as 1966 unfolded.
Before considering how monetary policy should react, however, it
was necessary to recognize that the System was operating in a new
environment of monetary, fiscal, and wage-price constraints.
At
present it was difficult to forecast how business would react to
the more vigorous action on the guideposts and hence to determine
precisely how monetary policy would fit into the new over-all mix
of public policy.
Moreover, Mr. Bopp continued, the tining of any policy move
must be weighed carefully.
erable pressure.
Financial markets were now under consid
In order to gain some insight into developing
pressures, the Philadelphia Bank had taken a look at corporate
sources and uses of funds and held discussions with treasurers of
several large corporations in the Third District.
In general, it
was found that pressures prevailing in the corporate sector stemmed
primarily from:
(a) the normal seasonal increase in bond offerings
at this time of year, (b) that increase superimposed upon a cyclical
uptrend in credit demand, and (c) some marginal pressures resulting
from anticipatory borrowing by firms which hoped thereby to assure
availability of funds and avoid possible higher interest rates in
the early months of 1966.
11/23/65
-72
An examination of data on investment spending and cash flow
in manufacturing suggested that, while investment spending tended
to peak in the second and fourth quarters of the year, internally
generated funds tended to be at a low ebb during these quarters,
creating a seasonal squeeze on cash positions.
Moreover, the squeeze
currently coincided with what appeared to be a cyclical decline in
the ratio of internally generated funds to total investment spending,
creating further pressures for outside financing.
Those pressures were confirmed by many of the treasurers
with whom he and his associates talked, Mr. Bopp said, individuals
representing industries ranging from oils, chemicals, and instruments
to steel, construction, public utilities, and transportation equip
ment.
Well over half of the treasurers stated that internally
generated funds were insufficent to meet current and projected
spending plans and reported increased reliance on external financing.
They reported that their needs for current and projected financing
were primarily to meet firm spending commitments, though some
suggested they were feeling pressure to acquire external funds now
in anticipation of higher interest rates next year.
As Mr. Bopp saw conditions in financial markets, and as he
appraised the new environment in which monetary policy must operate,
he felt that this was not the time to tighten further.
Also,
considering tnat the first quarter of 1966 might be less buoyant
11/23/65
-73
than some expected (with continuing steel inventory runoff, the
social security tax bite, and a leveling in auto sales), he would
be inclined to wait until seasonal pressures passed and a clearer
outline of 1966 emerged before deciding whether additional
monetary restraint was called for.
He favored alternative A of
the draft directives, with Mr. Mitchell's suggested modification.
Mr. Patterson said the Atlanta Reserve Bank's tabulation
of announcements of new and expanded manufacturing plants indicated
that half way through the fourth quarter the announcements of
investments in that part of the country were already approaching
the record third-quarter volume.
This would fit in with the
national McGraw-Hill findings, although the two series obviously
were not comparable.
Having talked with some of the Sixth District's leading
bankers, Mr. Patterson was more than ever convinced that liquidity
had much deteriorated for banks generally, although he would agree
that a bank-by-bank analysis was nece sary to determine over-all
liquidity.
ever.
District banks were relying on Federal funds more than
But there were limits to that supply, and some banks were
becoming increasingly worried about what would happen if they had
to tap that source simultaneously.
Some Atlanta banks had started
to issue small amounts of unsecured notes, primarily to test the
market.
With loan demand showing no signs of letting up and
11/23/65
-74
Governments being used for collateral rather than liquidity
purposes, Mr. Patterson had the uneasy feeling that banks were
looking to the discount window as their source of liquidity.
Resort to the discount window obviously should not be the banks'
principal line of orotection, and it was restricted in any case
by the fact that banks held limited amounts of eligible assets.
As bankers generally woke up to that state of affairs, he would
expect them to react by restricting any rapid loan expansion.
Anticipating such self-tightening--which might already be
taking place if changes in interest rates were any indicationMr. Patterson believed that the System should not tighten its
reins, at least for the time being.
He would adopt alternative A
of the draft directives.
Mr.
Patterson added that, as he had already noted,
some of
the Sixth District's banks--cramped by the ceiling on CD rateswere beginning to solicit funds in
subterfue.
a way that he considered
Would it not be preferable, he asked, to allow banks
to compete freely for time deposits?
lifting the time deposit rate ceiling.
Personally, he would favor
And if that were done, he
would be prepared to support some compensating open market
operations and a technical change in the discount rate, because it
was known from previous experience that a change in Regulation Q
might lead to an acceleration in deposit expansion, which he would
11/23/65
-75
consider unwarranted in the present economic climate.
In terms of
timing, he would be guided by those closer to the problems of the
Treasury.
Mr. Shuford commented that the economy had passed through
the steel inventory adjustment with business activity in general
continuing to expand at a rapid pace.
Industrial production,
employment, and retail sales rose from September to October,
maintaining the rapid rates of expansion that had prevailed since
a year ago.
The recent rise in business activity appeared to be broadly
based.
Strength in business equipment and defense industries and
in some consumer lines contributed to a high level of output and
employment during the recent period of steel inventory adjustment.
There had also been substantial increases of employment in trade,
service, and State and local government.
Now that the decline in
steel output had halted, that sector of the economy should give
added impetus to the present advance in business activity.
Fiscal and monetary developments had contributed to the
current expansion, Mr. Shuford noted.
The full employment budget
surplus fell to about zero in the third quarter, and was expected
to remain at that level in the fourth quarter.
The surplus
averaged $4.8 billion in 1964 and was running at a $6.7 billion
annual rate in the first half of 1965.
The money supply had
11/23/65
-76
increased at a rapid 6.4 per cent rate since July and had risen
4.3 per cent over the past year.
Both of those rates were high by
historical standards.
Mr. Shuford thought the economy might be approaching the
point where such a rapid expansion in aggregate demand as was
occurring would result in less increase in real product and more
price rises.
The limiting factor might be labor resources rather
than industrial plant capacity.
The over-all unemployment rate
now stood at 4.3 per cent and the rate for married men at 2.1 per
cent; both rates were significantly lower than a year ago.
Furthermore, expanded draft calls and increased college attendance
would continue to impinge on the available supply of young workers.
That group was among the most mobile of labor force participants
and would normally be utilized in areas of labor shortages.
In Mr. Shuford's appraisal, prices had risen significantly
during the past year.
In view of the continued rapid increase in
aggregate demand and a possible limit on the ability of production
to match such an expansion, price increases might accelerate.
There was a great deal of official concern with price increases,
and that concern seemed to him to be well taken.
But he was
puzzled that the treatment most discussed and followed was
administrative control.
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11/23/65
It seemed to him the Committee should bear in mind that
the economy had achieved advances in output and employment, at the
expense of some price increases, through increasing total demand
by means of fiscal and monetary stimulation.
Whenever prices were
rising as a result of market forces, that probably meant that
total demand had been pushed up too rapidly and that containment
of prices should depend primarily on some cutting back of demand
by fiscal and monetary measures.
Taking into consideration the strength in total demand,
which was exerting upward pressure on prices, as well as an apparent
escalation of the U.S. commitment in Vietnam, which might add
further to total demand, Mr. Shuford thought a tightening in mon
etary policy was desirable.
be accomlished.
He was not sure how this could best
The problem of timing was always of concern, but
he was persuaded that action should be taken promptly to raise the
discount rate.
He had been thinking in terms of a 1/2 per cent
increase, but the analysis by Mr. Irons had much to support it.
It seemed to him that a little further discussion on that score
might be needed, and perhaps additional discussion on the matter
of timing.
But it occurred to him that hardly ever was a
completely desirable time found for a move of this kind.
He was
not sure it would be any easier to reach a decision in January
than in December.
Since it was his opinion that action was needed,
11/23/65
-78
he would favor moving without undue delay sometime in the first
part of December.
Mr. Balderston commented that he thought the Committee was
approaching a time of decision, which pleased him because of his
belief that continued adherence to the status quo--in itself a
decision of sorts--could lead to real trouble.
U.S. exports were still insufficient, even when supplemented
by the return on foreign loans and investments, to cover U.S.
outlays abroad, Mr. Balderston observed.
The Government had failed
to exert enough restraint upon its foreign spending (partly because
it was embroiled in war) and U.S. corporations had not curbed
sufficiently their direct foreign investing for equilibrium to be
restored.
Clearly, U.S. export prices would have been even more
competitive if more of U.S. gains in productivity had been applied
to price reduction.
Failure to restrain bank credit was frequently
defended on the ground that wholesale prices had not risen very
much, so efforts to prevent further advances would be premature.
The point was that with magnificent productivity gains the nation
had had the choice between wage advances and price reductions.
If
prices had fallen, U.S. export competitiveness would more nearly
match U.S. political and military needs in foreign places.
But
failure to export enough caused dollar claims to accumulate month
11/23/65
-79
after month in foreign hands, and in sufficient volume to embarrass
the U.S.
Despite selective controls and a plethora of promises,
the loss of gold continued.
It seemed imperative that ebullience
not be permitted to boost prices and lose the competitive gains
of the past few years.
Mr. Balderston's second point had to do with interest rate
distortions and bank illiquidity.
The distorted interest rate
structure of the moment reflected the fact that the administered
lending rates of banks were out of tune with the increased rates
on open market paper.
That distortion was pointed up by the acute
pressure upon rates within the range, rough.y, of 3 months to
3 years.
Because the rate structure was out of balance, there
were troublesone distortions in flows of funds and uses of finan
cial instruments.
Those included increasing bank reliance on
high-rate promissory notes to raise funds because such notes
circumvented the Regulation Q ceiling.
This accentuated the
problems of bank supervision because, on those notes, banks
neither observed reserve requirements nor adhered to the rate
ceiling.
Because banks had retained the 4-1/2 per cent prime rate
as other interest rates rose, it had become a cut rate and had
attracted business that otherwise would have gone to the capital
markets.
That additional business had come from large corporations
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11/23/65
whose loan applications could not easily be turned down by banks
on whose boards the heads of such corporations sat.
Therefore,
such credit restriction as banks had introduced tended to fall upon
small and medium-sized concerns.
Although banks would not admit
to doing much credit rationing as yet, commercial finance companies
reported increased applications from smaller businesses that
claimed to have been discouraged at their banks.
The therapeutic action required to straighten out the
unfortunate rate structure of the moment might well be an increase
in the discount rate accompanied by a similar increase in Regula
tion Q ceilings.
Mr. Balderston's concern about a 4-1/4 per cent
discount rate, which on technical grounds might be defended, was
that the market would be waiting for the other shoe to drop.
Also,
friends of the U.S. abroad, who had been hoping for many months
to see strong, definite action taken by the monetary authorities,
perhaps would be disappointed.
Mr. Balderston recalled that at the meeting of the Committee
on October 12 he sought to state the case for re-examining current
monetary policy.
the following:
Among the points he had made at that time were
Wage pressures, combined with Government spending
for war and welfare activities, suggested to businessmen that things
would cost more later on.
coming year were favorable.
In addition, business forecasts for the
As a result of those rising
11/23/65
-81
expectations, both actual and projected plant investment volumes
were strong.
Thus business loan activity had been exceptionally
heavy throughout the year, even though the current annual rate of
increase in business loans was only one-half of the 20 per cent
rate of increase for the first nine months, because long-term
credit demands had been diverted from the open market to the banks.
The bind in which the bankers now found themselves would
not have been so tight, Mr. Balderston commented, if the bankers
had had the courage to utilize the pricing mechanism in guiding
or forcing customers to secure their funds through channels
appropriate to the use of the funds.
But that did not happen, and
now the Federal Reserve in its supervisory capacity faced the
System
responsibility of remedying the chaotic rate structure.
action would have been more effective at on earlier date.
But
there had been a succession of Treasury financings, and it was
probably better to act late than never.
If the System acted--and
there was not much time left before the next Treasury financing
operation--the appropriate open market policy probably would be
represented by alternative A of the draft directives.
If the
System did not act with respect to the discount rate and Regula
tion Q, then he would favor some other polic .
Mr. Shepardson remarked that the bulk of the criticism
he had read of System policy over the past 10 years was to the
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-82
effect that the System usually moved too late.
It was said that
the System could not arrive quickly enough at a decision.
It was
too late to tighten, when tightening was appropriate, and too late
to ease when that was appropriate.
This, in his opinion, was one
of the problems with which the System had to deal.
Chairman Martin commented that over the past two years he
had been proud to preside over the Federal Reserve System because,
despite continuing differences of opinion, the debates had been
on a consistently high level.
Having said this, he would also
say that he considered it unfortunate that the System had been
divided and cntinued to be divided.
He had always felt that when
the System was united it occupied a strong position within the
ranks of the Government.
When divided, the System was in a less
strong position.
As long as a high level of unemployment prevailed and
resource utilization was clearly below any reasonable level, he
did not think there was too much trouble in debating the "easy
money" and the
"not-so-easy money" schools of thought, and that
was fundamentally what the debate had been about over most of the
past two years.
The "easy money" school had thought that some
moves the Committee made were mistakes, when the Committee made
them, and he respected that view.
11/23/65
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But, Chairman Martin said, he wanted to make his own point
of view clear this morning.
arrived, and
He thought the time for decision had
he wanted the record to reflect his opinion that it
was not possible to run away continually from making a decision.
It could be debated at length whether a situation of full
employment existed and whether the resource utilization level was
entirely adequate.
It could also be debated whether a monetary
policy move at this juncture would have any impact from the
balance of payments standpoint.
He happened to think that it
would, and he had thought so for a good while, but this was
certainly a debatable point.
But to revert to the paper he had
read at the October 12 meeting--and had discussed at high levelshe thought the financial problem was acute when conditions reached
a point where, regardless of the decisions made by the Open Market
Committee, it was necessary to support a Treasury financing
operation in order to make it successful.
some who would
While there might be
disagree with him, he did not think there was any
doubt that except for official purchases for Treasury accounts
and except for System support the latest offering of the Treasury
would not have been successful.
Talk about market expectations, Chairman Martin noted,
could work both ways.
In the market today the expectations were
just as much that the President would not allow any interest rate
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changes as to the contrary.
That created a very real problem.
The
Treasury expected to announce another financing on the 16th of
December.
Therefore, if the System was going to make any move now,
it must do so before that time.
He did think, however, that this
week would be too early.
When it came to what to do, the Chairman remarked, there
was clearly a difference of judgment around the table.
Mr. Galusha
had said that he was a bit uneasy, and he (Chairman Martin) also
One could not know what construction would be placed
was uneasy.
on any move on the part of the System.
In his own mind, there was
no question about the strength of the economy.
But there were all
sorts of philosophies about how to handle the situation.
There
was the question of selective controls versus general controls.
When one moved into a period like the present, a tendency developed
for people to say they agreed on the need for some action, but to
add that the problem should be handled entirely by selective
controls.
Nevertheless, the System did not have selective controls
at its disposal, and whether one favored their use or not they were
not likely to be available fast enough to be of any value.
If the
System waited until mid-January, and if the budget turned out as
he thought it would, he believed it would be too late for monetary
policy to have any effect on the course of events.
There was quite
a difference, admittedly, between interest rates and steel,
11/23/65
-85
aluminum, or copper prices.
But without arguing the wisdom, or
lack of wisdom, on the part of the Administration in rolling back
aluminum or copper prices, he thought that if one were going to
roll back those prices because of a fear of inflation, one also
ought, at the same time, to permit an adjustment of interest rates
to restrain inflation.
The two things were compatible--not
incompatible--as operating techniques.
Chairman Martin observed that it was necessary to make
fundamental judgments at this stage.
It was easy for him to make
a judgment because he believed the country was in a period of
creeping inflation already.
And he believed the balance of
payments situation would be benefited by more restraint in the
over-all economy.
fast at the moment.
In short, he thought the economy was going too
This was where one came up against the basic
problem--to wiich he did not know the answer--relating to the
economics of full employment.
of thought.
Here there were different schools
Personally he felt that
t sone point, if the economy
went too fast, the possibility of achieving sustainable full
employment would be destroyed.
And he thought the situation was
about at that point now.
Accordingly, he did not have any real difficulty with his
line of approach.
When it came to the implementation, though, he
11/23/65
would hesitate to move in
-86
the manner that he understood
Ellis and Daane were suggesting,
that is,
by reducing the level of reserves in
Messrs.
to pursue a firmer policy
the reservoir.
He thought
that the demand forces in the economy were so strong that even with
a slight increase in the amount of reserves in the reservoir there
would still be a rise in interest rates.
was in
Therefore, the Committee
the relatively fortunate position of not having to tighten
money per se.
The difficulty of the moment,
the Chairman added,
had been
compounded by the banks' unwillingness to deal with their own
problem; in his judgment they had let themselves become bound into
the prime rate in a ridiculous way.
unraveled at some point.
But the situation had to be
It could be unraveled by a decline in
business, although he hoped it would not.
The other way--the only
way that he felt would be effective--would be to move on Regulation
Q and the discount rate and to continue the level of reserves
during the period of transition, or perhaps even to increase the
level slightly during the period of transition so as to make the
adjustment less difficult in terms of the over-all economy.
That was where he came out, Chairman Martin said.
As to
the directive, he thought the Committee probably could agree on
alternative A and probably could not agree on alternative B.
There seemed to be a clear majority in
favor of alternative A.
11/23/65
-87
In this framework, Chairman Martin continued, he would
personally be prepared to approve a discount rate action, if taken
by any Reserve Bank, prior to mid-December.
To run too close to
the next Treasury financing would, of course, be a mistake.
He
would expect, also, that if the Board approved a discount rate
change it would make a change in the Regulation Q ceiling.
Chairman Martin commented additionally that it must be
remembered that the Open Market Committee did not set the discount
rate, just as it did not fix reserve requirements or margin require
ments.
The Committee meetings were used as a forum for discussion
cf System policy generally,but no commitment could be made with
respect to the discount rate.
The Board would have to act on that,
and he could not anticipate how the Board would act.
He had merely
wanted to make it clear that for his part, as one member of the
Board--and assuming a continuation of present conditions--if any
Reserve Bank should come in with an increase in the discount rate
he would
be prepared to approve.
He would not vote to approve,
however, without an increase in the Regulation Q ceiling also.
He was not suggesting that anyone act on the discount rate; he was
merely expressing his present position and indicating how he would
react, as one member of the Board, if such action were taken by a
Reserve Bank.
11/23/65
-88Chairman Martin repeated that a majority of the Committee
appeared to favor alternative A of the draft directives.
be willing to go along with that directive himself.
He would
If, however,
some members favored alternative B there was no reason why they
should not so record themselves.
Mr. Daane asked the Manager whether alternative A meant to
him a restoration of the degree of firmness that had prevailed prior
to the aberrations of the recent period.
Mr. Holmes, in reply, referred to the diverse trends in
various market indicators, even allowing for the aberrations of the
past 3 weeks.
At the moment, for example, he was looking at
estimated net borrowed reserves of $200 million for the present
statement week.
Federal funds were now reported to be trading at
3-3/4 per cent, and the bill rate was unchanged.
With this sort
of mix in the figures, it was hard for him to say in advance exactly
how the specific indicators were likely to develop.
Mr. Hayes said that he agreed with the Chairman on the
directive and that he welcomed the Chairman's statement of position,
with which he found himself in complete agreement.
He also
concurred with the comment of Mr. Shepardson about the tendency on
the part of the System to be too late in reaching policy decisions,
and with the Chairman's comment about the futility of trying to run
away from decisions.
As he listened to the comments around the
11/23/65
-89
table, he had been impressed by the evident reluctance in some
quarters to make use of one of the System's policy instrumentsthe discount rate--even recognizing that there were always some
uncertainties in the market that might be exaggerated by such a
move.
He was impressed by the arguments of Mr. Daane, which to
him were about as compelling arguments for a discount rate move
as he had ever heard.
As he understood Mr. Mitchell's comments,
they implied that the choice was between no change in policy and
favoring a reversal of the economy.
Certainly no one would want
to advocate a reversal of the economy.
about was prevention of overheating.
All that anyone was talking
The fostering of stable
economic growth did not mean that one favored a contraction of the
economy.
The difficulty he found in the suggestions of Messrs. Ellis
and Daane was that he did not quite see how policy could be firmed
in the open market area without immediately creating even more
serious problems than now existed by virtue of the Regulation Q
ceiling, which in turn was closely related to the discount rate
itself.
Mr. Daane had said that perhaps there was not much
difference from the standpoint of timing between his two altern
atives, and it seemed to Mr. Hayes that the System's latitude as
to timing was distinctly limited.
If a move was not made shortly,
the Treasury financing schedule might preclude any action until
late in February.
Perhaps there would be some room in January,
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11/23/65
but it
ras necessary to recognize the possibility that if no move
was made in the next week or two,
the System might be blocked out
for a couple of months.
Mr. Mitchell commented that obviously there was not a man
at the table who would admit wanting to turn the economy downward.
However,
there were those who wanted to take steps that in his
opinion would lead to such an end.
He agreed with Chairman Martin
that many differences within the System's ranks related to questions
of timing and degree, but there was another much more fundamental
difference.
This was the belief on the part of many that cyclical
fluctuations were inevitable,
would have to come down.
that sooner or later what went up
If one said the System usually did not
act until too late, it was implicit in the analysis that if the
economy rose, at some point it had to turn down.
Mr. Mitchell
said he recognized that there were nany problems in keeping the
economy moving forward at a sustainable rate of expansion.
Chairman Martin liked to say, it was a tough job.
As
But he felt it
was possible to go far beyond previous accomplishments in terms
of continuing expansion.
of almost 60 months,
There had now been a period of expansion
and he did not think one should assume that
at the end of 60 months there would have to be a downturn.
He
would be more cautious than some in treating the condition of the
economy and in doing anything that might upset the rate of expan
sion.
This was the fundamental difference between his thinking
11/23/65
-91
and that of some others.
In most other respects, he thought the
questions at issue might turn out to involve differences of
judgment on the matter of timing.
Mr. Danne remarked that he had not been talking so much
about a reduction in the reserve reservoir---to use the Chairman's
figure of speech--as a containment of reserve availability within
bounds.
He was thinking specifically of net borrowed reserves
somewhat above $150 million--a containment of the reservoir rather
than a reduction.
He thought that with the demands the market was
likely to experience in the days ahead, this would produce a
market that would be much more supportive of a rate change than
today.
Mr. Maisel referred to the Chairman's comments about the
situation having reached a stage where it was necessary to deal
with the economics of full employment.
He felt the situation
required walking a tight rope that was admittedly hard to walk.
He still hoped, however, that incomes policy, as opposed to monetary
policy, would continue to be used at this point.
In his judgment
the Administration had properly been using incomes policy.
If a
change were made now to monetary policy, that would amount to
giving up.
It would amount to saying that the System did not
favor the present way of handling national policy and therefore
was going to use monetary policy.
There were two basic points-
how to walk the tightrope and whether to continue to walk it.
11/23/65
-92
It should be clear that he felt that not changing interest rates
was very definitely a part of the economics of full employment.
Chairman Martin commented that he did not think it was
really a question of "either-or;" it was a question of "both."
Mr. Ellis said that just because one was concerned about
the quality and structure of expansion, as well as the rate of
expansion, this did not necessarily mean that he had a limited
horizon on the length of the expansion.
System action could be
taken as reflecting concern about the conditions of expansion,
rather than adoption of a view that a downturn was just ahead.
Referring to his earlier statement about putting on the
brakes, Mr. Shepardson said that he perhaps misspoke.
He did not
mean to imply the imminence of or need for a turndown but rather
a slowing of the rate of expansion to a more sustainable level.
By way of analogy, he mentioned the situation of the Texas
homebuilder desiring shade for his home.
He might plant the fast
growing Chinaberry which would provide quick shade but which is
short-lived and extremely brittle in a storm.
Or he might plant
live oaks which are slow-growing but long-lived and hardy and
would provide shade for his children and grandchildren.
His
preference, Mr. Shepardson said, was for the live oak, and
likewise, in this instance, for courses of policy that would
promote longer-term economic growth, even though a somewhat less
rapid pace of expansion might be involved.
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11/23/65
Chairman
Martin then alluded to the modification suggested
earlier by Mr. Mitchell in the language of the first paragraph of
alternative A of the draft directives, and he inquired as to the
wishes of the Committee members.
Mr. Hayes expressed a preference
for the original language of the draft directive, particularly
since he felt that the introduction of the phrase "financial
resources were in shorter supply" was troublesome.
Others who
spoke on the matter indicated that they would be agreeable to the
proposed modification except for the phrase to which Mr. Hayes had
referred.
Thereupon, upon motion duly
made and seconded, and by unanimous
vote, the Federal Reserve Bank of
New York was authorized and directed,
until otherwise directed by the
Committee, to execute transactions
in the System Account in accordance
with the following current economic
policy directive:
The economic and financial developments reviewed at
this meeting indicate that over-all domestic economic
activity is continuing a rate of expansion comparable to
that of the third quarter despite the contractive effect
of a reduction in steel inventories. Business sentiment
continues optimistic and financial conditions are firmer.
Meanwhile, our international payments have remained in
deficit. In this situation, it remains the Federal Open
Market Committee's current policy to strengthen the
international position of the dollar, and to avoid the
emergence of inflationary pressures, while accommodating
moderate growth in the reserve base, bank credit, and
the money supply.
To implement this policy, System open market
operations until the next meeting of the Committee shall
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11/23/65
be conducted with a view to maintaining about the same
conditions in the money market that have prevailed
since the last meeting of the Committee.
Mr. Shepardson commented, with respect to his vote on the
directive, that he had not dissented from the adoption of this
directive because of his view that the policy move he thought was
needed could appropriately come in the form of a discount rate
increase.
Absent such an expectation, he would have favored
alternative B of the draft directives.
Chairman Martin observed, in this connection, that he felt
the views of the respective Committee members would be reflected
adequately in
their comments that would be included in
the minutes
of this meeting.
It
was agreed that the next meeting of the Committee would
be held on Tuesday, December 14, 1965, at 9:30 a.m.
Thereupon the meeting adjourned.
Secretary
ATTACHMENT A
CONFIDENTIAL (FR)
November 22, 1965
Drafts of Current Economic Policy Directive for Consideration by the
Federal Open Market Committee at its Meetng on November 23, 1965
Alternative A (no change)
The economic and financial developments reviewed at this
meeting indicate that over-all domestic economic activity is
expanding strongly in a continuing climate of optimistic business
sentiment and firmer financial conditions. Meanwhile, our inter
national payments have remained in deficit. In this situation, it
remains the Federal Open Market Committee's current policy to
strengthen the international position of the dollar, and to avoid
the emergence of inflationary pressures, while accommodating
moderate growth in the reserve base, bank credit, and the money
supply.
To implement this
until the next meeting of
view to maintaining about
that have prevailed since
policy, System open
the Committee shall
the same conditions
the last meeting of
market operations
be conducted with a
in the money market
the Committee.
Alternative B (firmer)
The economic and financial developments reviewed at this
meeting indicate strong further domestic economic expansion in a
climate of optimistic business sentiment, with strong credit
demand and some continuing upward creep in prices. Meanwhile, our
international payments have remained in deficit. In this situation,
it is the Federal Open Market Committee's current policy to
strengthen the international position of the dollar, and to resist
the emergence of inflationary pressures by moderating growth in
the reserve base, bank credit, and the money supply.
To implement this policy, System open market operations
until the next meeting of the Committee shall be conducted with a
view to achieving somewhat firmer conditions in the money market
than have prevailed since the last meeting of the Committee.
Cite this document
Federal Reserve (1965, November 22). FOMC Minutes. Fomc Minutes, Federal Reserve. https://whenthefedspeaks.com/doc/fomc_minutes_19651123
@misc{wtfs_fomc_minutes_19651123,
author = {Federal Reserve},
title = {FOMC Minutes},
year = {1965},
month = {Nov},
howpublished = {Fomc Minutes, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/fomc_minutes_19651123},
note = {Retrieved via When the Fed Speaks corpus}
}